Poor Matthew's Almanac

Trice Burned

2011-09-23T03:28:00.000-07:00

I wonder...

If it take three fails to learn a lesson.

And as I used to say, "We have the right to fail, try again and then quit."

And hope triumphs over expectation.

There is less quavering retail money in this market than ever before.

Everyone is committed.

We are going to see a higher low.

Breathtaking...

2011-08-27T01:47:00.001-07:00

cf. November 20, 2009

Live! Tonight! The Depressions feat. D.J. Demand Destruction

2011-08-22T23:20:00.000-07:00

. . . . . . . . . . . . . . .

Dear Dad,

The recent developments in the global economy are terrifying. The risk to the economy now is entirely political-- trust in politicians worldwide is low, and by the look of recent events, I fear this is morphing into something new all together. In America, Europe, and the Middle East, it's no longer just people hating their politicians-- it's people questioning the very nature of government's authority, right to exist, and place in society. Society has become, I'd say, significantly less civil in the past eight weeks. You see this in the riots in London, you see this in the riots in Greece, you see this in the downright dangerous political language being bandied about in the US.

Gov. Rick Perry of Texas, candidate for President of the United States, stated yesterday at a fundraiser that Ben Bernanke's actions were equivalent to treason and by extension that Federal Reserve should be abolished. That this is possible right now... that that could even be possible given our country's obvious problems, and the tremendous body of literature showing how bad it was back in the day. (c.f. "Fifty Years in Wall Street" Clews, 1908) and the practical steps one could take fiscally... in conjunction with a little bit of swagger, charisma and monetary policy. Insane. Rick Perry is insane and unfit to be president. (Not that bashing the Fed is without historical precedent) As a result, the Europeans woke up to an America that looks way more dangerous than they anticipated. More and more, we feel the same about them. Repeat, Rick Perry should be shot for treason.

This feels really, really bad to me. This is not the same situation as when we spoke 5 weeks ago and I advised you to do nothing because the debt ceiling debate was a foregone conclusion. Indeed I was right, but many horrible things have happened since. For one, in the most recent GDP report, the final numbers for quarter 1 & 2 came in and they were horrible. Not something like 3.5% & 1.5% as previously reported, but something like 1.5% & 0.5%. Furthermore the Q4 decline in 2008 was newly revised down in light of more complete data, from -4% to -9% with similar adjustments to Q1 of 2009. And S&P downgrade of America. America is like, whatever, we just approved a bunch more NRSROs and we're gonna sue your ass for the "sub-prime crisis." Remember that the sub-prime crisis? Ben Stein's simple 200 billion dollar problem. God... those were the days. So much easier back in summer 2007 when I thought everything was going to turn into a combination of the the Great Depression and 1970s stagflation overnight or at least definitely by Christmas. Remember? I had just started dating Sadie Stein and I called you after our first date and told you I wanted to marry her? Its funny, I never told you this cause you'd would have been furious but that summer I stole a copy of Bernanke's textbook on the Great Depression from the Border's Books in between the NYSE and the American Stock Exchange. Sort of a performance-art piece. Actually that piece is getting more poignant all the time. Wow... Oops. Remember the ASE? Such a pretty building. I was there, walking by, freaking out about paper money and gold's potential potential, the day they announced its closing. Heard about it from a trader smoking a cigarette. January 2008. So sad.

We were freaking out back then too... alongside long suffering Mr. Greg Robb: Fed Watchers at a Loss: 01/27/08

And all of this feels really especially bad.. because all of these things taken together are ancillary, just colorful background to the slow motion banking collapse ripping through European Union as we speak.

[Insert current ten year DB chart as well as ten year soc gen, ubs, west lb, bank of america, j.p. morgan, kbe and XLF and the european equivilent, vix, the euribor-ois, dollar basis swaps, euro, gold, gold:spx, & maybe the ted spread though i don't know if there's action there yet.]

[And also my unrequited dream chart of the moment, GLD price v. GLD tonnage.]

* * *

I believe that the amazing recovery of corporate profits has masked a cancerous deterioration of the broader economy over the past 2.5 years. These profits are due to permanent efficiency and productivity gains realized by the corporations. Gains that have elevated unemployment structurally and to lasting effect. Maximum employment, thought in the 1970s to be 3-4% is now very likely to be 6.5 - 7.5% at best over the next decade. This is bad.

Furthermore the return to healthy corporate profits has masked a truly disturbing fissure in wealth distribution, one which has occurred almost silently over the course of the past 2.5 years of economic recovery. There are now only three classes of people: those without retirement savings, those with retirement savings, and the rich. The return to healthy profits has torn a massive rift between the approx. 50% of the population with and the 50% without. This is bad for stability and probably has contributed to the decline in civility amongst our politicians.

You know what this adds up to once the stock market figures this out? Bad. To reduce all of the above to an equation: too little Demand + too much industrial capacity = ^ odds of Depression

And this overcapacity is a worldwide phenomenon right now. Keep in mind that things were not scarce during the Great Depression. There was a ton of nice things, new exciting inventions and technology, at amazingly cheap prices, with eventually --by corporate necessity-- ample financing, just no one had any money to buy or desire to finance anything. Sound familiar? Indeed, perhaps the brilliant promise of globalization has temporarily (i.e. for the past 4 years and for the next 10 or so) overheated. To put it another way, we are a victim of our own success, because we did not recognize and correct the tremendous global imbalances while they were building. I don't know how you feel but I blame, Alan Greenspan, Dick Cheney and the Chinese first and foremost.

The worst part of everything is that the Fed is probably going to announce a certain brilliant technocratic innovation/experiment at their meeting next week, one which they've been hinting at recently. As far as I can tell from watching and reading a lot of CNBC and NY Times, WSJ, etc. the market has no idea this move is coming and is not going to understand it one bit. It's confusing and scary sounding to the lay man, and involves the Fed imposing a negative interest rate on the deposits Banks have placed on reserve with the Fed. Its insanely complicated actually, and indeed, actually takes economics about as far towards metaphysics as... I can't even start to get into this, it a long lecture... but basically, its an attempt to force the weird/ethereal money created during QE1 and 2 into the real economy. I have no idea if it will work, but it fucking brilliant and definitely on the cutting edge of the current research coming out of academia. People are either gonna love it, or hate it. Its definitely the right thing to do, but people might fucking panic. I don't know.

If you agree that the latest developments politically worldwide are scary and that this could go terribly terribly wrong... I have a plan which, had I been more knowledgeable in 2007 before all this started, could have saved us a lot of aggravation over the years. Here is what I would like you to do. Agree to wager up to 5% of your retirement savings on a truly catastrophic decline occurring in the stock market by December 2013. If shit gets really bad, you will probably suffer only half the loss you would otherwise take on your portfolio. If the economy recovers, the most you could lose is that 5%.

You would get Justin to purchase a contract from the stock exchange. This particular type of contract is widely utilized and called a "put option." It states, for instance, that if the S&P is below 900 at any time before December 2013 you are entitled to redeem your contract for the difference in between the two prices. For instance, if the S&P is goes to 700, your contract is worth $200. Now because the market is currently at 1120 and the lowest it hit in 2009 was 666, the price for you to buy that contract is likely to be pretty low, perhaps a few dollars or so. If you take 5% of your portfolio and agree to risk it on this contract, you are likely to insure a good proportion of your savings in the outcome of a true disaster. If the economy just muddles through or recovers and takes off, the maximum you can lose is that 5% you used to buy the contract. Pretty slick. That's why the options market exists. To provide insurance. It started to help farmers manage their commitments. Interesting, no?

What you would be doing is a very routine operation employed by every CFO on the planet, everyday, to manage macro-economic uncertainty. Justin is definitely well versed how to execute this strategy, its a qualification for his license.

If this sounds plausible, send me the go ahead. I'll explain the concept to Mom and if she agrees with our assessment, she can call Justin. I know i've fucked this stuff up in the past, but I've had 3 years to study up since the last time. If I could quantify the risk, I would be less alarmed. But because the risk is entirely political, and because humans have been bad at politics domestically and abroad for their entire history, I am fucking' terrified.

FYI, I know you're performing eyeball surgery in the Namibian bush, but if you have the time, these articles from ftaphaville.ft.com lay out the outline of what the Fed is going to announce at Jackson Hole next week:

The High Powered Money Problem

The Fed's Secret QE3 Equivalent

The Fed's 1.6 Million "Somethings"

Love,

Matthew

Finance is awesome.

2011-02-20T23:49:00.000-08:00

Swap contracts for Saudi Arabia, used as a measure of confidence although the country has no debt to insure, jumped 11.5 basis points to 138 last week, the highest since July 2009.

The $124,000 Query

2011-01-25T23:28:00.000-08:00

"Ahh... I don't know about that," is the answer to most questions.

Especially the really hard ones. Like, some really stupid shit someone says to put you on the spot. It works because no one who is fucking with you thinks two steps ahead.

Seriously. This will be the only thing I will teach my children.

Weighing the US Dollar

2010-10-11T21:42:00.000-07:00

Debt is the New Equity

2010-08-30T18:49:00.000-07:00

The relationship between the yield on stocks and the yield on bonds is inverting in a way that hasn't been really since before the 1950s. But the concern regarding this "strange" behavior should stop. The strength of bonds (both Corporate and Government alike) is a reflection of a healthy and necessary shift in the capital structure of our economy.

Investors have pulled 50 billion out of the US stock market this year. This money has gone into cash (both Savings Accounts and Gov't Bonds), corporate bonds (Junk and Investment Grade), and ex-first world equities.

The foreign equity story is simple. Countries with strong property laws, stable governments and a youthful demographic, will see an increase in economic growth as people compete to raise their own standard of living.

But the massive amount of money that has moved into fixed income, has bewildered many market commentators. The extremely low yield of both regular and inflation-protected Government Bonds has many people worrying about deflation. They are right to worry. Cash parked with the government is money not spent. The momentum of money is slowed down.

This adjustment is part of a larger system of balanced interactions. The shifts in money flows cause prices to change. These prices act as signals, encouraging shifts in the behavior of participants. These behavioral changes in turn, affect money flows and the process is repeated.

Lets trace the path of these signals. Falling stock prices scare people. This is because these prices telegraph signals about the health of an economy. People decide to hold more cash, which means either directly or indirectly purchasing government bonds. This allows the government pay a lower rate to borrow money.

But message contained in Gov't Bond rates is more multi-faceted than simple warning of deflation . It is also a reminder to investors that if they want to earn any return on their money at all they will have to take some risks. If they are forced to invest in something, their best option is to choose the second safest thing to cash, loaning their money to corporations. We can confirm this behavior signal by observing the large money flows into Corporate Bonds beginning about a year and a half ago and continuing to the present day.

This behavior shift has lowered corporate borrowing rates to the lower range of their historical levels (and when I say historical I mean as far back as two hundred years.) We have seen an enormous shift in the cost of borrowing for corporations since the darkest depths of the financial meltdown. In December 2008, the price at which an investor could be persuaded to lend money to riskiest corporations hit a level which implied he figured his risk was 50/50. Even the rates on the best run corporations were implying defaults of nearly 10%.

This flow of money, signaled by the extremely low corporate rates (I.B.M. just borrowed some money for less than two years at a rate of 1%) is telling us that the best run companies in their respective fields are going to be allowed to continue to do good work. Times will get tough in the months ahead, the stock market will fall. But the necessary shifts in our economy will now have the chance to occur. The process of creative-destruction will remain in balance and the engines of creation will not be helter-skelter destroyed.

All we are witnessing is a cyclical transformation in our economy from its recent youthful speculative exuberance to a more considered, mature and frankly world-weary countenance. Keep hustling, and it will be ok.

Knees and Toes

2010-06-20T20:29:00.000-07:00

The U.S. Stock Market is currently tracing out the final part of a head and shoulders pattern. While I've stated before that most technical analysis is bunk, the H&S is a common "topping" pattern that can occur at major tops and bottoms of long market trends. It begins when an asset is bid up to unsustainable levels. A correction follows, encouraging the types of people who "buy on dips" to enter the market. The asset then rises to slightly above the previous peak, but runs out of steam as no further buyers enter the market. It then falls again to around its previous lows. I suppose the same buy on dips argument could be made for what drives the asset to rally a second time. I also feel however that the movement of stock prices often tends to take the path that would most frustrate the largest number of people. So perhaps the second rally simply exists to frustrate the less sophisticated short sellers. Perhaps the professional short sellers close their bets in anticipation of this pattern forming. This is the great thing about the markets, there is never one explanation.

I can tell you that three weeks ago I felt there was a large chance of this pattern forming. (A fact which I conveniently failed to mention on this blog.) Here's why. The stock market tends to never behave the same way twice. People's observations of the market's past behavior cause them to change the way they react when they encounter a similar situation. The last time the Dow Jones Industrial Average broke through 10,000 in 2008 it smashed through it. Its that simple. It was unlikely to do so again. The stupidest money would bet on the same thing re-occurring facsimile.

If this sounds like bullshit, I assure you, it is. You cannot approach something that acts so irrationally, rationally. But I can also assure you, if I've learned one thing in the past four years, the market and its participants are seldom rational. And the more obviously an effect should follow a cause, it almost never does. This, mind you, is not the same as being contrarian. It is more subtle than that. But now there I go... more bullshit.

There were two other reasons it was unlikely to smash through 10,000 three weeks ago. There was very strong resistance around 10,000 due to the fact it marked the previous low from February 2010, and the fact that big round numbers tend to act as psychological landmarks and consequently many people make decisions around them. (Furthermore, many world indexes were battling up against large psychological resistance numbers, the FTSE 100 @ 5000, the Shanghai Composite @ 2500, Gold @ $1250, Euro/USD @ 1.20, Copper @ $3.00) Secondly, large lasting trends do not simply reverse course on a dime. A trend reversal is a large scale battle between two groups with opposing opinion. It takes time for them to fight it out and a victor to emerge.

The Dow will most likely stall before 10,800 (just north of the first peak in the pattern from January) There will be a lot of congestion, as people start to recognize this pattern and the market moves to frustrate the greatest number of people possible. But then it will fall and not stop until at least slightly south of 8000.

Here are a few head and shoulders examples... (Click to view larger.)

The Large Cap (Dow) 2007 Peak:

The Small Cap 2007 Stock Top and 2008 Gold Bottom:

A possible long term H&S?!? (I saw this theory advanced by some quack but who knows...):

Of course, this is the true underlying picture. (Inflation adjusted, Log Scale, 1950-2010):

Inflation

2010-05-23T01:17:00.000-07:00

The wide ranging criticisms of the ECB's performance are bullshit. An inflation target necessarily implies restraining deflation.

There are several independent, but non-mutually exclusive causes of inflationary pressure. Academically, the two classical causes are termed demand-pull and cost-push. Additionally, one must consider the Milton Friedman fallacy that "inflation is always and everywhere a monetary phenomenon."

Demand pull inflation is always and everywhere a monetary phenomena. People can ask for all of the increases in wages they want... But in totality, if the central bank doesn't print enough money to keep up with economic growth, an employer's ability to increase wages will be constrained by their employee's ability to increase his productivity. There will simply not be enough money in the system to stimulate the economic growth needed to encourage an additional consumption of products.

This goes both ways. When Arthur Burns ran the Federal Reserve, he allowed Richard Nixon to bully him into printing money. The continuation of Johnson's "Great Society" push to appease the opposition to Vietnam through increased social spending coupled with the credit creation abetted by the Burns Fed. This double-whammy over-stimulated a strong economy already close to its natural limit of unemployment. The additional money in the system temporarily drove the unemployment rate below 4%. As people were driven off their couches by rising wages, so to were people driven to ask for higher wages to stay at their current jobs. With rising wages came higher expenses, and the demand-pull wage spiral took off.

This is not at all the case today. Europe is on the verge of a terrific period of stagnation and deflation. (inflation=up, deflation=down, dis-inflation=steady) We will see no economic growth, and no additional jobs in the periphery of the Eurozone until the artificially uncompetitive wages of the peripheral economies come back down. America is going to be relatively okay, but with lackadaisical wage growth, stagnant real-estate prices and impressively high unemployment for four years at a minimum.

The price mechanism is a powerful signal. Despite the extremely bearish situation in the world economy, the prices of many key commodities are at extreme levels. This tells us several things: Coffee and cocoa are expensive. Global income/consumption is rising.
Oil is expensive. We are running out of oil.
Coal is somewhat expensive. We will find more coal.
Wheat, soybeans, and corn are cheap. We have had three years of excellent harvests worldwide... we also have powerful subsidies in the U.S. for these crops.
The prices of many rare earth metals have been relatively unaffected by the panic of '08/'09. Global income and the consumption of advanced technological goods is rising and perhaps we are running low on these metals.

Get it? We will find more of the things we are short of globally, except the things we are running out of, namely oil. But on a macro scale, the developed countries are printing more money, and the developing countries are consuming more products. The deflationary impulse of the developed world is being countered by both the printing of money (Friedman inflation), the demand pull of economic growth in the developing world, and the cost push of the world transitioning from an oil based economy. Add in a few years of bad harvests and we will move beyond academic disputes over the nature of the Phillips curve (the reciprocal relationship between rate of inflation and and the rate of unemployment) into a general acceptance of Gregor Macdonald's concept of compartflation...

Basically we are talking really shitty stagflation in the developed world, with the slim possibility of outright deflation if we get a trade war, or a real war, or a European banking collapse, or a revolution in China... etc, etc. In either case, developed world real estate prices will not appreciate in nominal terms for 8 years at least. Stocks and and paper stores of value look terrible.

It is essential to recognize that the dichotomy between deflation and inflation is false. They can easily coexist as a growing differentiation between assets values intensifies along the classic lines of supply and demand. As we enter into a world where the values of the dollar and the euro depreciate together due to both the decreased demand for currency and the increased supply of money, we will see the price of many assets in high supply (real estate, stocks) stay stagnant. Thus the inflation of the money supply will cause a subtle but dramatic deflation in the price of over-abundant assets. However, as we run of of cheap energy the price of oil and coal will continue to inflate with drastic consequences for the world economy.

This will of course work itself out. Indeed, as these events come to pass, market prices are no more than the manifestation of this process of self renewal.

Stop freaking out, you know you're okay.

2010-05-16T23:31:00.000-07:00

The Dow is going somewhere just south of 9000. The Euro is going to $1.15. Gold is eventually going to $2400, once the dollar turns around.

Will everyone please calm down? The markets are working.

The only present concern is the fact that everyone who can is bailing out of long-term European peripheral-economy debt by selling it to the European Central Bank. The amount the ECB is actually purchasing is the only relevant data point. If they are forced to purchase excessive amounts, they will not be able to sterilize their purchases, turning so called "credit easing" (I've also heard the nonsense term "qualitative easing" used) into "quantitative easing." In fact, the Federal Reserve fell into a liquidity trap when they attempted their form of "sterilized" quantitative easing, and were forced to print money to prop up the falling money supply.

If their hand is forced there is a real danger the Euro will hit parity to the dollar. (Or as my fiancee suggested, falls below parity... "It's only fair.") So far the adjustment is in line with events, and the re-balancing of the Euro is equating supply and demand of money and goods judiciously. But if parity happens, America and Europe will be in deep shit.

Moody Blues

2010-05-09T23:36:00.000-07:00

Moody's downgraded Moody's Investment Services today, in response to Moody's receipt of a Wells notice from the S.E.C. which threatens to revoke its NRSRO status.

God I wish this were true. Who knows?... stranger things have happened.

Re: Letter to Trichet

2010-05-09T23:03:00.001-07:00

Uh... so I guess he got the memo. I was thinking something more on the order of 2 trillion dollars, but $962 billion sounds reasonable. Glad I could be of service.

Letter to Trichet

2010-05-08T16:45:00.000-07:00

At the risk of sounding brash, I believe that Jean-Claude Trichet made a major tactical error Thursday morning by muting calls for the ECB to initiate quantitative easing.

The argument against QE in Europe is that the ECB's actions would necessarily be political, possibly opening up the ECB to scrutiny and jeopardizing the central bank's independence. However, the exigencies of the crisis necessitate bold action and I am surprised that Trichet would allow himself to be caught flat footed on this issue. He was unique amongst central bank governors in the summer of 2007 when he (by fax from the beach) provided unlimited liquidity to the European banking system. This bold action ameliorated the onset of the panic of '07.

Trichet is attempting to restore normality to the markets by withdrawing this liquidity support. This is a mistake. Trichet should have said that the ECB was prepared to come into the market with overwhelming force to drive down the unproductive interest rates on European government debt. With the TED spread and the LIBOR-OIS spread approaching panic levels (in plain English, European banks are no longer lending to each other overnight) he should have reiterated his commitment to provide unlimited liquidity.

If he feels that the "traditional" QE is unpalatable or unworkable, he should initiate a political process by which German bunds (the yields on which are currently plunging do to "safe-haven" searching) are issued and the proceeds used to purchase the debt of weaker European countries (which are in danger of being priced out of the lending markets due to their surging yields.) If this were implemented on a significant scale, it could go a long way towards driving a convergence between bond yields on the debt of European countries.

This may be a good opportunity to raise a domestic issue I've been kicking about in the back of my mind. The political separation between the two control levers of the economy, Fiscal Policy (the Spending and Taxation decisions made by Congress) and Monetary Policy (the control of overnight interest rates by the central banks) is necessary but unworkable. If I were in charge, I would make a commitment to restrain overnight interest rates around 0% for three years. Any adjustment necessary to restrain inflation by choking economic activity should be made on a quarterly basis by manipulating the tax rate on corporations and individuals. This is of course politically impossible, however, it cuts to the heart of the biggest danger facing the economy today, the surging national deficit and the possibility, however remote of a U.S. sovereign default. By increasing taxes temporarily if necessary to restrain economic growth, the government would bide its time by funding the exploding national deficit. This would increase its ability to maneuver by stocking some dry powder in the case that additional Keynesian stimulus is required. Which it will be.

Dance Casa

2010-05-05T00:24:00.000-07:00

Also, what the fuck happened at the art sales this week?!? Excuse me for swearing three times in three posts within this hour, (I'm sorry, I got bored and stopped paying attention for three weeks worth of trading days) but $25,842,500 for a 28 inch forearm/hand by Giacometti???

Felix Salmon had an excellent post a few weeks ago. He suggested that works of art produced in limited multiples had a higher value than a unique work of art. That the cache derived from the narrative surrounding the provenance of the sister pieces would speak to the sophistication of the new buyer... to brutally paraphrase his excellent article.

But the fact of the article was that a huge Giacometti had just sold for something like $50 million dollars.

So here we have: the beginnings of bond vigilantism in the European Debt markets, the beginnings of a"1930s U.S. depression style" overproduction thing happening in China, massive surpluses of oil and basic industrial commodities, shortages of rare earth metals and soft commodities (such as coffee, cocoa, orange juice), a severe long term shortage of oil, a short term shortage of coal, Japan done and borrowed twice its GDP, excellent harvests several-years-running depressing the prices of agricultural products, and a tiny fucking Giacometti selling for half the price a monumental sized Giacometti sculpture.

Again. What is going on???

Here's the deal. We are, luckily, not going to have a post-banking system collapse how the fuck do we pay the police if the ATMs don't work kind of situation. But things are very bad. Terrible in Europe. Terrible in New York. Terrible in China.

Less than perfect in L.A., Austin, Brazil... but go to any of these places if you need to. There is oddly enough work.

Thirty-Nine Percent

2010-05-04T23:44:00.000-07:00

39% of investors in the iShares/FTSE Xinhau A50 China Index ETF have lent their shares to short sellers. In the words of the immortal Drake, "Who the fuck are y'all?"

Holy shit.

2010-05-04T23:39:00.001-07:00

(Update 5/6/10) Yep...

Strong demand for U.S. Debt Auction

2010-04-08T02:01:00.000-07:00

The liquidity trap has a floor. It also apparently has a ceiling.

Bids for the $21 billion auction of 10-year U.S. government debt attracted the highest demand on record today, as investors, scared, bet on deflation or couldn't think up any better use for their money.

Homage to Clyfford Still

2010-02-20T00:50:00.000-08:00

The depreciation of the Euro (blue) and the Dollar (orange) against Gold.
[The purple has no significance in itself. It's simply caused by the overlap of the two colors. Sometimes it's the Euro and sometimes it's the Dollar. It depends on which currency is stronger and thus in the background.]

From Gregor.us

2010-02-19T23:59:00.000-08:00

The most disturbing thing here is the breakdown of the price mechanism- the contraction in non-OPEC oil supply despite the 2008 price surge.

It is clear that oil supply is plateauing. The price surged for coal in 2008 as well, but its discount relative to oil encouraged adoption. Gregor Macdonald predicts recapitulation into a predominately coal-biased global economy within five years.

Luxury Goods

2010-02-04T00:35:00.000-08:00

"Luxury is a necessity that starts where necessity stops."

- Coco Chanel (attrib.)

The story of civilization, if told with economy yet in all its comprehensive beauty, can most cogently be explained through the evolution of the unnecessary goods of society. These are the most interesting aspects of civilization and in many ways the quintessence of peaceful society. Civilization is the story of the specialization of labour, the rise of trade, and the creation of a leisure class of scholars and artists and dissipated wealthy. All of these narratives revolve around the unnecessary good.

The unnecessary good exists outside of the dynamic equilibrium that governs supply and demand because its logic befuddles the balancing power of price. Sadie and I have a toast to the unnecessary. It's simply, "Fearless luxury."

If you wanted to ask my 17 year-old self his opinion, he'd tell you, "The moment a good's fundamental utility disappears, it becomes art."

These days I'm more of a Pierre Bonnard man.

Risk on.

2010-02-01T20:25:00.000-08:00

Prices are starting to look somewhat reasonable for the first time in over a year:
Coal Company stocks and physical Lead are both down 20%.

Brazil and India down about 15%

I hadn't been aware of the recent performance of the Estonian economy until today, but for the very compelling reasons outlined in John Dizard's article in the FM section of the FT the other day, I believe this fund would provide good diversification to a not-Dollar portfolio. Estonia is on track to join the EU next year, so investing in its stock market provides Euro exposure without the structural weaknesses of the European economy.

SEB Eastern Europe Small Cap Fund

The Dollar is close to median value against the Euro ($1.35) and strong against the basket of currencies which make up the dollar index.

I think we are entering the moment where the paths diverge between the V-shaped recovery of low debt, youth oriented, growing economies, and the W-shaped recovery of the over-leveraged, sluggish, aging countries.

Remember the international investing formula detailed before on these pages. An successful economy and candidate for investment must contain Attractive Women + Quality Music + Decent Educational Opportunities + Young Population + Low Debt/GDP ratios + Accelerating Credit Expansion (installment plans, mortgages, etc.)

With Quality of Music and rate of Credit Expansion counting the most in projections.

Non-Specific Observations of the Energy Markets

2010-01-29T23:13:00.000-08:00

This is a picture of the incredibly tight correlation between the price of wholesale gasoline and the yields on 10-year U.S. Treasury Bonds. I've suggested before that this may be due to the fact that unleaded gasoline is a perishable commodity and thus its supply is most tightly coupled to the short-term economic outlook, but I don't know. It's interesting though, no?

This is a picture of KOL, an ETF comprised of coal related companies. Though most markets are exhibiting classic technical analysis resistance patterns, this chart wins the award for pristine textbook example. (If your new to T.A. here's a hint... ignore the bullshit. All you need to know are 'Resistance can become Support', the Head and Shoulders formation (on long-term charts only) and 50 & 200 day moving averages. Everything else is worthless.)

By the way, maps show you where to go. Charts show you where not to go. This is important.

Anyway... the consumption of coal has sky-rocketed this year relative to oil because it is a much cheaper alternative. There are some posts on my favorite economics blog, gregor.com, related to this subject which are excellent for both the quality and inventiveness of Mr. Macdonalds' writing and the accompanying charts. In addition to his theories on our current inflationary depression ("compartflation,") today he made the bold and sensible prediction that, "It was only 55 years ago that the world crossed over to use more oil than coal. In another five years, we will be going back to coal." Here is a link to a post of his with jaw dropping charts of recent trends in world coal consumption.

[btw/fyi... Gregor Macdonald, George Cooper, Satyajit Das, Bill Gross, and Mr. Soros (back in his prime)... the smartest guys in the proverbial room]

Missed Connections

2010-01-29T21:42:00.000-08:00

A few thoughts on the State of the Union address. Not on what Obama said, but on what he didn't say and perhaps should have mentioned:

1) "The dollar is much stronger now then it was before I became recognized as a viable candidate for president... in fact, almost to the day of my speech at the Brandenburg Gate."

(Not that this is necessarily a good thing, or necessarily indicative of a casual relationship... though I personally believe that in the midst of the Freddie and Fannie nationalization of July 2008, Obama's appearance on the world stage marshaled confidence in the Dollar, which immediately began to pull forward against all other currencies. This was in no small part a consequence of the stamp of imprimatur bestowed by Paul Volcker's early presence on Obama's economics team... Conveyed correctly, the above statement could have been the most positive populist thing he could have said to the "American people" as they, a bit bullheadedly, really favor a strong dollar. It's simply patriotic chauvinism.)

[Incidentally, the so called "Palin effect" in the first three weeks of her candidacy on John McCain's rising poll numbers was I believe due instead to Obama's initial effect on the dollar. Dollar strength knocked the wind out of commodity prices and gasoline prices came rapidly down. This caused the widespread elation for a moment, as it seemed (to the uninitiated) that the "economy" was getting better. Of course, in short order the tail began to wag the dog as falling demand began a collapse in commodity prices which amplified the dollars surge. And then Lehman... and McCain/Palin was history. Flight to safety, indeed.]

2) "This trillion dollars I have spent since taking office is largely in line (proportionally) with the total amount spent by Europe to combat the panic and as such we are no worse off fiscally on a relative basis."

(Also a brief explanation of what an overnight shift in household savings from -2% of GDP to +6% of GDP does to an economy, along with an explanation of why only government spending can make up for the shock of such a sudden chasm in consumption... Yeah, that would have been helpful.)

Here we go!

2010-01-20T19:00:00.000-08:00

So as the forecast on December 8th, 2009 predicted ("Short-Term Dollar Strength on Worldwide Crappiness") the Euro is now within spitting distance of $1.40 to the dollar. So far so good. But the ferociousness with which it smashed though its 200 day moving average makes me inclined to wait for further weakness rather then booking profits now. I believe that the Dollar will certainly hit $1.35. Depending on the management of the Grecian crisis, the Euro easily could fall further but $1.35 is a recurring motif I feel comfortable with.
(It was the exchange rate when I first started paying attention to the markets in 2005, it was the rate just before the panic began in late July 2007, and there has been a lot of congestion around $1.35 over the past year.)

In other news, readers of this blog will note that I have been pretty bearish throughout the past year. Not to the point of outright shorting the S&P 500, but certainly not holding any long U.S. equity positions either. The theme since December 6th, 2008 has been to pursue a simple "reflationary" strategy, with a diversified portfolio split between base metals (LD, +141%), rare metals (1211.HK, +524%), junk-bonds (PHDAX , 46%), Brazilian and Indian Equities (EWZ, +156%, INP, +129%), and Inflation-Protected Government Bonds (TIP, +11%). This strategy was intended to be long only, with a "buy on dips" mentality.

I believe it is time to close out this portfolio and move to cash. Investor bullishness is the highest its been since 2006. China is removing liquidity. The VIX is near its 3-year lows and Junk-Bonds have returned to yields not seen since the moments before the panic in July 2007.

We may be moving into a new phase of the crisis. The big story of the Panic of 2008 was the run on the "cyber" banks, the money-market accounts where investors park their cash. The sudden withdrawal of cash from these accounts after the Primary Reserve fund "broke the buck" ushered in a wave of forced selling as money-market accounts sold their investment holdings to meet redemptions. We are unlikely to see a liquidity panic of this sort again. It is likely that the troubles in Europe will spread in unexpected ways. The specter of a Greek sovereign default will seriously undermine faith in the European Monetary Union, and until there is a clear protocol for dealing with the Greek crisis, we may very well see a solvency panic of the sort which accompanied the failure of Lehman Brothers.

I am not suggesting that this crisis is imminent, simply that the December 6th, 2008 portfolio reallocation has made stunning, one-in-a-lifetime returns, and there is enough uncertainty to the outlook to take a breather and reflect.

I am a firm believer that equity investors must be burned three times before a true bull market can begin. I've never read this anywhere, it simply seems like a prerequisite to the necessary capitulation which allows assets values to reach appropriate valuations for the onset of a bull market. I mark the bursting of the tech bubble as burn #1 and the panic of '08 as burn #2.

As a corollary to this thought however, I would reiterate my comments of last spring. The questions regarding L, W, or V shaped recoveries are misplaced. With the increasing globalization of the world financial markets and the shifting demographic patterns between developing and developed markets, I believe we will see a W-shaped recovery in the 1st world and a V-shaped recovery in Brazil and India.

We may very well be approaching half-time in this (so far) three year long bear market. Don't let anyone try to fool you into thinking otherwise.

Sovereign Default Swaps and Corporate Risk Premiums

2010-01-12T20:17:00.000-08:00

The price of insuring the European Union against a member's default rose above the price to insure Europe's companies against default today for the first time since the height of the financial crisis in March 2009.

Meanwhile, the risk premium to own the riskiest safe corporate bonds instead of 30 year government bonds (and their "risk free" rate of return), has narrowed to the smallest spread since July 2007... the moment just before the panic began.

Debt Deflation : The Echo of Inflation

2010-01-08T21:40:00.000-08:00

When one spends using credit and the interest rate on that debt is hiked, (arbitrarily to 29.99% in my case) it is the same as a sudden burst of price inflation on every good that one has ever bought with that credit.

It is almost like a strong echo.

This has been happening nationwide ever since the passage of the new consumer finance laws last fall. While the rules are excellent in many ways, they also severely restrict a bank's ability to price risk appropriately. They also have the effect of modifying, in a sense, the contracts that govern credit card master trusts- one of the securitization vehicles that made credit so cheap over the past decade. This dramatic change in their financial architecture has happened without the underlying contracts being strictly violated. The foundations of their profitability, however, been shaken, and since these trusts a revolving this may have caused a profound shift in their desirability as investments. This marks a permanent shift in the credit landscape, partially ameliorated by this recent skulduggery, but likely to have continuing consequences as new credit issuance is restricted to consumers and small businesses.

The jacking up of interest rates on everyone's credit card balances will prove to be highly deflationary. We will see the effects of this disgraceful practice by May.

Art Market Rules

2009-12-28T15:47:00.000-08:00

(A beautiful Van Dyck self-portrait from his late period. $13.5 million as of December 9, 2009... shocking, given that the previous day a throwaway sketch by Raphael went for $47.5 million and a perfectly ordinary Rembrandt self-portrait went for $32.7 . Though I wonder if my infatuation with this painting is partly due to its astonishing and perfect frame. It is scandalous that museums' information labels universally fail to account for the origin of a painting's frame. Nothing else in cultural history is so elementary and evocative of its moment.

A painting's frame speaks of successive generation's conceptions of space- this tension in art between art's utility as a decorative object and art's function [forgive me here for Elijah Craig's influence...] as a metaphysical text. In no other media can you learn as much about the sophistication and empathy of the owners or curators who have lived with the art itself in its intervening years.)

* * *

My dad told me a funny anecdote he once heard. When asked about the price of Rembrandt painting he had recently purchased, Norton Simon said something to the effect of, "Well this painting probably cost about a dollar in 1650 and its worth about 5 million now, so all in all art appreciates at a fairly boring rate of return."

At the end of his book "The $12 Million Stuffed Shark," Don Thompson sets out some tongue in cheek rules for purchasing art:

"With the work of western artists, what kind of painting will appreciate most? There are general rules. A portrait of an attractive woman or a child will do better than that of an older woman or an unattractive man. An Andy Warhol Orange Marilyn brings twenty times the price of an equal-sized Richard Nixon.

"Colors matter. Brett Gorvy, co-head of contemporary art at Christie's International, claims the grading from most salable to least is red, white, blue, yellow, green, black. When it comes to Andy Warhol, green moves up. Green is the color of money.

"Bright colors do better than pale colors. Horizontal canvases do better than vertical ones. Nudity sells for more than modesty, and female nudes for much more than male. A Boucher female nude sells for ten times the price of a male nude. Figurative works do better than landscapes. A still life with flowers is worth more than one with fruit, and roses are worth more than chrysanthemums. Calm water adds value (think of Monet's Water Lilies); rough water brings lower prices (think of maritime pictures). Shipwrecks bring even less.

"Purebred dogs are worth more than mongrels, and racehorses more than cart horses. For painting that include game birds, the more expensive it is to hunt the bird, the more the bird adds to the value of the painting; a grouse is worth three times as much as a mallard. There is an even more specific rule, offered by New York private dealer David Nash: painting with cows never do well. Never.

"A final rule was contributed by Sotheby's auctioneer Tobias Meyer. Meyer was auctioning a 1972 Bruce Nauman neon work, Run from Fear/Fun from Rear, which referred to an erotic act. When the work was brought in, a voice from the back of the room complained, 'Obscenity.' Meyer, not know for his use of humor on the rostrum, responded, 'Obscenity sells.' Often it does not, but for a superstar artist like Jeff Koons or Bruce Nauman, it does. It did."

* * *

(A very early Robert Irwin. Probably the kind of painting he would have destroyed later in his career, if given half the chance. Sold September 24th, 2009 for $16,000. Estimated in May 2009 for $80,000-$120,000. It went unsold at that time.

I'm not sure (heat of the moment and all) what it would have sold for had I been present in the room. But I assure you, if we check back on this painting in a few decades we will find this buyer got the the deal of the century.

I don't mean to insinuate that I particularly like this painting. But centuries from now, when the concept of the post-modern has long ago become but the conceit of only the most pathetic of Ph.d types trolling for a brutally sloppy and disease ridden end to a pathetic gang-bang worth of a dissertation topics- Robert Irwin will be viewed a one of the men who brought the progression of modernism from its origins in multi-plained abstractions of Cezanne and the shimmering equal-luminescences of Monet to its apotheosis in pure perceptual bliss. And this crappy early abstract work will certainly achieve a perfectly respectable rate of return.)

Short Term Dollar Strength on Recognition of Worldwide Crappiness

2009-12-08T19:03:00.000-08:00

We've reached a short-term inflection point in our general asset reflation scheme. General worldwide crappiness and uncertainty will lead to a short-term dollar strength. Safe-haven searching, a general one sided bets against the dollar, and a slightly brightening U.S. Economic Outlook will assist this move.

An overview of volatility-driving upcoming events:
The next due date for part of Dubai World's debt is on Dec. 12th. There is an upcoming important court decision on the restructuring of the first bankrupt Islamic "Sukut" bond.

The steep downgrade of Greece's debt today, is going to force the European Central Bank to spell out its long-term support of excessive Greek borrowing. The ECB is lending to the Greek banks, which in turn are holding large amounts of Greek Government Bonds. This is complicated by the fact the Greek banks are barely solvent. And the Greek Government is broke. This uncertainty about the European Monetary Union will negatively affect the euro until the issues concerning the weaker states are resolved.

The Japanese have been hurting due to their currency's strength against the Euro and Dollar. Intervention is possible, probably by the enlargement of the Central Banks relatively un-extended balance sheet.

The amount of correlation between general asset prices over the past year has been quite incredible. Gold, oil, and stocks around the world has fallen for the past several days. The dollar has been rising.

We are about to witness short-term correction in the dollar's long-term decline.

I believe the stimulus dollars are beginning to enter the general money supply. There's a hum in the air on main street that whispers of a significant increase in the velocity of money. Money is a momentum- a product of its quantity and the speed at which it moves. Money is coming out of the mattress and being spent. In labor news, the employed are working longer hours. People are taking home more weekly pay, despite hourly wages continuing to fall. This suggests overtime.

Finally in other news, an extremely destabilizing bill just passed the House Financial Services Committee, which if enacted into law will severely restrict credit by shutting down some portions of the interbank lending market, and introducing new destabilizing panic pathways into the overnight market. Also worth mentioning is the accounting rule change going into effect in January, bringing all of bank's off-balance sheet entities back onto the balance sheets.

In short, short-term dollar strength probably clustered around $1.40 against the Euro lasting around than three months. Higher US stocks relative to Gold but lower in general. Lower Europe Stocks. Brazil lower but not as far. Other emerging markets with deficits, harder hit.

Forecast

2009-12-02T22:27:00.000-08:00

Real Estate. We are in the midst of an inflationary depression. On one side we have the ravages of debt. On the other, an uneasy coalition between the printing press and the psychology of a people.

The government will continue printing dollars to support the economy. Debt which pushed up asset values will now cause them to deflate as people pay down their debts instead of buying. The over-leveraged will continue to experience pain and their defaults will further damp asset values. The government prints dollars under different names but its key effort is to replace the personal spending that is now devoted to saving.

The rise of gold is unremarkable. Against copper, gold has risen about 40% since the beginning of 2007. Against oil, gold has risen 60%. Against stocks, of course gold is up 120%.

I'm not sure exactly how much gold has risen against "real estate," but with housing prices roughly down about 30% nationally, and gold up around 100%, we can all guess the relevant math.

Of course we are looking at values versus their peak, but that is exactly the point. The point in the past which we pick for measurement is arbitrary; we can only make decisions in the present. We are looking for the point at which we collectively hit our debt maxima, and we are guessing the point at which the government will target for suitable valuation.

Of course, this assumes that the government has any agency in the matter, which it does, but only indirectly.

My biggest mistake in the past 2 years has been trusting in the efficacy of printing dollar bills. It turns out this is an extremely blunt instrument. The government can no more guarantee asset values.

Our collective debt will hold down "real estate." But "real estate" values hold a reflexive power over broad swathes of the economy. The government will thus target a price level based on real estate values.

In this process, the government will anchor the values of all other goods. Tangible, fungible goods will attain a steady state value. Tangible but subjective/discernible goods, another. Subjective paper goods will suffer against common paper but against gold most of all. Gold, the most subjective of goods.

Regardless, under the best of scenarios, we will see "real estate" values depreciate by the scale of each buyer's dreams... assuming these dreams are rooted and leveraged in paper.

Real Estate- Unqualified Japanese Example

2009-11-20T21:31:00.000-08:00

The prospects for real estate in the United States are grim. This is the mechanism by which real estate deflates.

The adjustment in the world economy is accompanied by much higher interest rates in the U.S. This dampens the price of real estate. Prices will remain at the same level as today and not inflate along with the prices of food and energy.

Japanese House Prices 1979-2005:

Ignore the Hype.

2009-11-20T00:08:00.000-08:00

U.S. Stock Paper vs. Paper Gold since last Thanksgiving.

Asset Reflation

2009-10-12T23:51:00.001-07:00

Here is a simplified depiction of general asset reflation since March.

This unusual chart (which I invented, and indeed cannot remember how to generate... no future updates to this post -ed.) does not depict the relative performance of each asset. It is simply a portrait of the directional movement of several important assets.

The black line is an exaggerated graph of the 10 year Treasury Yield, which is a decent proxy for the desirability of holding cash. The yield can be viewed as a measure of deflation vs. inflation concerns. When the yield is low, deflation fears are rampant and cash is king. When the yield is rising, the economic situation is normalizing. Assets reflate as risk-taking resumes. As you can see, whenever the yield falls, all the asset prices in tandem move sideways. But they do not fall. This is asset reflation.

The next phase of the cycle will begin when the 10 year Treasury Yield moves through 4%. At this point, we will move from a general reflation of asset prices into an inflationary environment.

The most fascinating thing to take away from this graph is the high degree of correlation between these radically different assets. This has been especially dramatic since August as stocks, commodities and U.S. Government debt have all appreciated simultaneously. We are witnessing a widespread reflation of all assets. This halcyon period confirms that the Federal Reserve has won a tactical victory in the battle against deflation. Whether they can develop a strategy to hold the line against deflation while preparing for the battle against inflation remains to be seen.

Federal Reserve Bank of St. Louis President James Bullard gave an interesting interview today in which he stated the interest rates will not rise until unemployment begins to fall. This is a surprisingly candid remark from a Fed official linking the two sides of their dual mandate to maintain price stability and high employment. There are two interesting points to take away from this comment. 1) The Federal Reserve working firmly in the Jennings Bryan mode and investments decisions should be biased toward inflation and take into account a continually depreciating dollar. 2) The Fed is likely to rely on high unemployment to keep wage inflation down through raising rates as the economic picture brightens.

In short, I see the declining purchasing power of the dollar supporting continued price gains in non-U.S. assets and a sluggish U.S. economy that gradually re-balances as a weak dollar support its exports.

[Incidentally, in the chart, you might notice the high degree of correlation between the price of gasoline and Treasury yields. I suspect the difficulties involved in storing gasoline are contributing to its volatility. As the only perishable asset depicted, it exhibits the highest degree of sensitivity to the short term economic outlook.]

Time to go.

2009-09-20T20:30:00.001-07:00

I believe this rally has run its course and a correction is finally at hand. I expect the S&P 500 to move in a trading range between 850 and 1100 for quite a long time, a year at least. I'll write more in a day or so about my reasons for this, but for the time being this article is really interesting.

Checking in on the December 6th portfolio reallocation.

2009-07-23T16:35:00.000-07:00

(Click to enlarge)

Above is a performance chart of the portfolio I recommended on December 6th, 2008. The S&P 500 is included only to aid comparison.

One of the reasons I have not posted much recently is that I stand by the December 6th repositioning, and I have not come across any particularly good deals since. The repositioning was intended to be long only, with a "buy on dips" strategy.

Finland continues to underwhelm. In retrospect, there is no real reason to allocate any money to developed nations, and Finland was a bizarre nod to that notion. Agriculture has been flat do to excellent harvests. Other than that I feel pretty good about the whole thing.

Overdue Analysis

2009-07-23T13:49:00.000-07:00

Several things disturb me about the recent run up in stock prices.
1) The rally is concentrated in large cap and tech stocks. Small companies are lagging behind.

[First, an aside.... Stock prices are determined by what people will pay for them. Money must flow into (or out of stocks) for the price to change. These money flows are determined solely by fear and greed.]

The majority of investors today have been taught to pursue a buy and hold strategy. Overall, though discipline or ignorance these people refused to sell during the panic and thus set a floor under stock prices in March. Everyone who was inclined to panic, did.

These days the market is being driven by greed. Some people are worried they will miss out on the market rally. I consider these people unsophisticated speculators. For reasons I will lay out below, I believe the out-performance of large cap and tech stocks signifies a broad based lack of trust in the stock market. Buy and hold investors are not, by and large, buying.

In my unscientific analysis over the past two years, tech stocks seems to have exhibited more volatility than the overall market. They gained more on up days and lost more on down days. Therefore, day traders tend speculate in tech stocks because they are interested in making a quick, short term profit. The out-performance of tech stocks over every other market sector is worrying to me because I believe this sector is filled with speculators, looking for a quick buck. These money flows can reverse quickly and are not sustainable.

Unsophisticated speculators, tend to invest in companies that are readily recognizable. These tend to be large cap stocks like Google and Apple. The out-performance in large cap stocks worries me because it signifies that these stocks are being bid up due to the greed of unsophisticated investors. If greed was causing money to flow into lessor known stocks, it would signify a more broadly based participation in the form of disciplined buy and hold investors.

2) Finance stocks in the S&P 500 have not confirmed the rally over the last two weeks. They have been essentially flat since early May, and have stalled over the past week. The economy can not return to health until the banks do, and the banks are still in deep trouble, due to a combination of massive hidden losses on their balance sheets and sharply increasing defaults in their consumer loan portfolio due to rising unemployment. Perhaps even more worrying, the Regional Banks' stock prices have been falling since early May and are starting to approach their March lows.

3) The S&P 500 is approaching the psychologically important level of 1000 and is likely to encounter significant overhead resistance at this point. Around big fat numbers like 1000, people tend to start to worry they will overpay. Think of it like a candy bar. At 99 cents a candy bar seems like a good deal. At $1.10 you instantly feel ripped off. Even though 10 cents may be insignificant to you, you probably will chaff at the store owner for charging more than what you believe to be the fair price. There will be a moment of indecision where you wonder if you should wait till you come across another store, just to teach the store owner a lesson... or more accurately just to assert that you are not a rube.

While this is an extremely unfit analogy, (comparing a consumable to an investment) the principle nevertheless holds true. People will think the S&P 500 dear at 1001 points, realizing they could have gotten it cheaper in the weeks before. They will wait for a cheaper time to purchase it. In the most benign scenario they will wait to invest, stalling stock prices. In the most adverse scenario, the economy will continue to worsen during this period of indecision causing people to lose their nerve.

It is important finally to keep in that the exuberance of the stock market in the past week has been due to earnings being less bad than expected. They are still terrible. And as a final disclaimer, I follow the American Stock market only as an economic indicator. Under no circumstances would I put my money in there. See the post from December 6th 2008, titled "After the Gold Rush..." for details on my investments.

More of the same.

2009-05-29T22:59:00.000-07:00

Friday was unusual. The cost of cash and the price of gold rose together. Think of a shopkeeper cutting his prices even though his costs are rising.

The desirability of cash is the yield on the 10 year US Treasury Bond. If our country's creditors decide we cannot pay our bills the yield we must pay on our debt rises. If we don't want to buy anything from our foriegn creditors, our anything at all for that matter, prices deflate and causing the price of cash to rise. Cash becomes more valuable. And since more people need to store their cash somewhere, they put it in bonds causing the yield on Treasuries to go down.

Now, rising gold signifies a depreciating dollar. Cash becomes less valuable and people put their money into hard and soft assets like gold and stocks.

Today, gold rose and Treasury bond yields fell. This is illogical. I'd like to propose two scenarios. Either the government intervened in the bond market ("quantitative easing") or the pullback was natural. Stocks and commodities have risen more or less the same amount since the Thanksgiving bottom. This rise in asset prices has caused mortgage bond investors to insure themselves against the possibility that inflation could take off and the Fed would have to withdraw some of its support to the market by raising interest rates. The investors hedge by selling the 7 or 10 year Treasury bonds. In the last two weeks there has been a rush to do this causing a 0.75% rise in Treasury yields. This is dramatic.

Some guidance from 1933-37

2009-04-15T23:03:00.000-07:00

"Here we find another example of what would today be unthinkable... If you sell [someone Pounds (£) for January delivery] you could find yourself with no means to legally buy back your position. So strange as it might sound, they drove speculators out of the short positions. Government just didn’t want any short bets against them in any market. They sought to have their cake along with a full belly and free rent all at the same time. If it couldn’t be achieved by a free market system, then they would make up their own rules and limit the freedoms of the market to their liking.

"The last four months of 1933 were marked by numerous shocking issues. Many of the steps taken to force the markets to yield to the will of government are steps which will one day soon be reimplemented. Today we are all aware of the G-5 group of central banks and the political consensus around the world that promotes the manipulation of foreign exchange to achieve economic stability. The methods of the present are no different from those attempted by the central banks first in 1925, again in 1927 and finally by Roosevelt in 1933. In the September 25, 1933 edition of Time magazine, we find an interesting comment as to how the stock market was viewed to be a hedge against the currency inflation policies of Roosevelt. This is very important because I seriously doubt that anyone would view the stock market today as a hedge against inflation. Nevertheless, this issue was the primary factor which led the stock market into its rally which eventually peaked during 1937. Time magazine reported upon this aspect as follows:

"'Methods of hedging against inflation within U.S. frontiers have become a favorite coffee-&-cognac topic. Purchase of industrial stocks is, of course, the most popular hedge, but commodities and land have been creeping up fast since the NRA threatened profits with higher labor costs. Some shrewd businessmen with little capital at stake argue that the best thing is to go as deep into debt as the banks (or friends) will allow; eventually they will pay off with cheaper dollars. Carl Snyder, economist for the Federal Reserve Board, was asked lately by a wealthy friend how he could hedge against all possible contingencies including deflation or stabilization so that he would die as rich as he was at that moment. ‘One way,’ snapped Economist Snyder, ‘is to shoot yourself.’"

"The comment of economist Snyder in a very realistic sense was quite true. The only guarantee that one would die with essentially his current assets in this situation was to commit suicide for you never know what tomorrow would bring.

"There is no doubt that during the year 1933, the stock market gained significantly on the prohibition issue which anticipated that the country would turn "wet" as of January 1, 1934. But the entire issue of Roosevelt’s currency inflation had a large impact upon the performance of the market as well.

"The market began to rally finally from the summer of 1933 lows on the perception of a hedge against inflation. After a rally into January 1934, the market fell back and consolidated into a July low during 1934 once again. From there, commodity prices began to rally after the convertibility of gold for U.S. citizens had been officially abandoned in January 1934 and the effects of inflation began to spread throughout the world. Eventually, the inflation scenario continued to drive the markets higher into 1937.

"From March 1933 into 1937, stocks rose largely upon the belief that inflation would raise the price levels of commodities and therefore earnings would rise as well. Stocks were also viewed as a hedge against inflation as we read in the September 25, 1933 edition of Time magazine. Therefore, we find some continuity in the analysis which took the position that stocks would rise in the shadow of commodities. This was largely created by the fact that much of the economy was heavily commodity oriented.
High techs were not exactly the rage of the times. Keep in mind that the automobile was viewed to be a large consumer of commodities. So we do find that there is some logic to the commodity relationship prior to World War II. But as the economy developed over the next several decades, the U.S. industrials and service oriented business sectors began to play a much more dominant role in the GNP of the United States. Thus, the concept of commodity relationships with the stock market has been divided and almost forgotten for the broad market as a whole.

"After inflation spending continued yet commodities and stocks declined from the 1937 high, that scenario of currency inflation disappeared and Roosevelt’s theories appeared to be a total failure."

-- 1933, from "The Greatest Bull Market In History", Martin Armstrong

Phronesis

2009-03-18T22:53:00.000-07:00

In America, people consume. 70%, in fact, of our spending (GDP) is consumption. Euphemistically cloaked as aspirational, patriotic, or necessary; we buy to feel.

The problem is not how much we buy. The problem is how consuming makes us feel.

A brief portrait of capitalism: Intellect facilitates cheaper and better products through innovation, cooperation, and competition. Workers cooperate to innovate. Corporations cooperate with their customers to disseminate goods. Competition between corporations for customers inspires innovation.

So we get a lot of cheap staples and low-cost, high-quality products.
Prosperity ensues. Happiness eludes.

The problem is fast fashion. Corporations pursue this calculus to its marginal conclusion. H&M provides the semblance without the substance. And we buy it because it makes us feel good and its cheap.

Cheap is not a bargain. Value is a bargain. And value derives from a feeling of well being. Not contentment! Value is dynamic, kinetic, masculine, and protagonistic. Value derives from agency. Value is subjective truth in the demilitarized cone of objectivity.

Price is the only truth. It is the price of cooperation.

Without haggling, we have no agency. Fast fashion forces us to haggle with ourselves. We derive not the Truth but the subjective truth of the moment. The pleasure priciple.

It gives us no victory because we have bested only ourselves.

They're not all capitalist pigs...

2009-03-18T06:37:00.000-07:00

Some are hipster douchebags!
Gerry Pasciucco, head of AIG's Financial Products division (the guys who brought down the firm)

-via Gawker

Hmm...

2009-03-13T10:23:00.000-07:00

Regarding a request from AIG to invest last September:

“It’s like taking out a girl -- sometimes you know it isn’t going to happen,” Buffett said “The time pressures, the degree of uncertainty, the depth of the possible hole, the need to get it through a regulatory body,” he said. “It wasn’t going to happen.”

Not quite as pithy as his former aphorisms such as, "When the tide goes out, you get to see whose swimming without their suit," but equally revealing.

Update:

2009-03-10T21:44:00.000-07:00

Today's Range on the Dow 6800-7200
The credit markets are extremely stressed, with the price of insurance on the riskiest companies setting records. This partially due to funding pressures at banks before they close their books at the end of the 1st quarter. The but the volatility has been low during the last few weeks as the stock market plunged. This suggests two things, sluggishness and lack of capitulation. This makes me think that everyone who owns stocks has either hedged against a further fall or has already decided to either bail or is resigned to lose more money. Therefore, absent the failure of a big bank, or some grave political uncertainty, the stock markets appear to be due a short term bounce of 20-30%. But the only certainty is that they will eventually have further to fall. We were too clever getting into this mess to get ourselves out so easily. And no one has given up completely yet. Everyone seems to think the stock market can't get any worse. Until everyone despairs, it will keep falling.

In inflation adjusted terms, 6800 marks the peak in 1966 and 4800 marks the peak in 1929. I personally believe that 4800 is where we are heading. (To see this chart click here) Below is a non-inflation adjusted chart showing the century long term trendline. According to this chart there should be support around 4800 as well.

2009-02-28T02:05:00.000-08:00

"But the Depression has also been misunderstood. It was not a period of great scarcity, but a period of unparalleled glut. There was too much of everything: too many factories turning out too may cars, radios., washing machines, and refrigerators; too much money around and too much of it into the hands of a few wealthy people who reinvested it in more factories and other means of production and to many people getting too much easy credit, which caused a further overstimulation of production.

The country's ability to produce had outstripped its ability to pay-and the nation paid for the mistake. As Will Rogers said, "America will be the only country that ever went to the poorhouse in an automobile." -Fascinating Facts from American History, By Bill Lawrence

Kinda like now, except our ability to consume has outstripped our ability to pay.

Une "Demode" Portrait du Volatility

2009-02-14T17:00:00.001-08:00

a LURID PICTURE of VOLATILITY

2009-02-13T01:58:00.000-08:00

From John Murphy, author of "Technical Analysis of the Financial Markets" (stockcharts.com)

"This is the most facile portrait of what caused this crisis" ...and other thoughts on the inauguration of Barack Obama

2009-01-20T19:10:00.001-08:00

Alan Greenspan is responsible for this crisis. He will be remembered for his tragic combination of ideological stubbornness and hubris. These were compounded by his age. Old age triggered a calcification in his thinking and myopia in his vision which rendered him out of touch and imperceptive to paradigmatic shifts in the world economy. In short, he was a victim of his own success and ego.

While the Federal Reserve's Fed Funds Target Rate played a large role in fomenting this crisis, it is not the whole story. The impact of China's rise, as transmitted through both the Wal-Mart effect on inflation and by China's massive interventions in the currency market, kept interest rate on long term U.S. government debt supernaturally low. This caused the stewards of our economy to fall asleep at their posts and the citizens of our country to become complacent.

Money was made too easy. She slept around, inflating the egos of people and the asset prices of things. Inevitably, we all got the clap.

Equally important is the human story. We, as humans, have a instinctive desire to avoid pain which has been encrypted and inculcated in us over the immense epoch of our genetic history. Often we construe falsehood with pain, when really we should embrace the opposite.

We see ourselves as rational creatures, and avoiding pain appears eminently rational. But this is fallacious. Avoiding pain is actually an emotional decision. Enduring pain in the pursuit of truth and some teleological utopos is truly rational. The ability to endure pain is characteristic of that higher order of thinking which separates us from all other creatures who possess no filter on their actions. Creatures who move before thought stalls in their brain with impulse as quick as synaptic transmission.

We, as a culture, failed in our fiduciary responsibility to ourselves. We allowed ourselves to be deluded. We delayed the tough decisions. We lived like children.

Alan Greenspan failed in his fiduciary responsibility to our nation. He let his desire to be liked, cherished and remembered overwhelm his thinking. This was not a conscious, pseudo-rational decision... its was an emotional one. But nothing is more insidious than the desire for popularity, as it corrupts truth, and posits the ends for the means.

The economy hasn't gotten laid in a long while, and he is frustrated. He lost his game when he slept with some hussy and got the clap. It is time for him to take his medicine.

Ambergris

2009-01-20T18:41:00.000-08:00

A financial adviser has a fiduciary responsibility to an individual.

But I feel that an economist, as I conceive of it, is a fiduciary to a community and to the future. He is an artist, who like a musician, is a friendly experiencer in an art that is invisible... conceiving in a reality that is at once terrifying, glorious and profound.

I feel that of all of the art forms... music, architecture and economics are the most abstruse and profound because to practice them involves perceiving, visualizing and inventing structures out of the invisible. time

I see my role as a protector of all of those in my circle, be it my parents, all my friends, or generation mgmt. This is more or less what I've been trying to accomplish here, though gnosis can't be transmitted piecemeal as it is in this media.

It is because of this that I often feel a tremendous burden and responsibility. It often causes deafening pressure and stress and frequently is the source of my (sometimes) erratic behavior. I did not start by seeking this role, but in a sense, I suppose, I have been performing as such my whole life in my desire for community and utopia. As I am the only one so qualified in my extended circle of friends, I feel that it is exigent and indeed requisite.

There are many of my friends who I know feel this existential pressure to express "it" in their art. This art is a reflection of the greater vision of our community and the pressure stems from this tremendous responsibility, nay fiduciary duty, to portray (what I, for lack of a better term, call) generation mgmt in the greatest light.

I wish you all the best, and if I ever appear to be too crazy, please know that I only have the best intentions...

I know that someday, we will all find our ambergris.

-Matty Talty

Czech Modern

2009-01-20T17:45:00.000-08:00

With all the hype and speculation surrounding Obama's impending bailout, I'd like to share some words of wisdom my 68 year-old Czech driver shared with me the other evening, “I’ve never seen an-y-thing more per.man.ent than a temp-ory govrn-ment pro-gram.”

Fuck John Galt

2009-01-18T02:49:00.000-08:00

Today, completely out of step with the times, the EU ruled that Microsoft could not longer bundle Internet Explorer with their Windows operating system without including their competitor's web browsers. It was deemed anti-competitive.

You know what is anti-competitive... an omnipotent, monopolistic government body.

Given that IE is total crap, many alternatives have sprouted up, and I do not know anyone reasonably intelligent who uses it. Its the equivalent of our moms and their AOL accounts... anachronistic and obsolescent.

So I say this to Microsoft. Rather than including several different browsers in Windows as the EU has forced you to do... include none at all. Then we will not be able even to use your stupid browser to upload a decent one, and we will be forced to drive to a store and pay for a "CD-ROM" containing a browser. Competition facilitates innovation, but the EU seems intent to live in the past and assume its citizens are all unthinking children.

Kinda a shitty metaphor for their monetary and fiscal policies, come to think of it...

Perspective from Satyajit Das

2009-01-16T14:14:00.000-08:00

1) Flat is the new up.
2) Debt is the new equity.
3) Dividends are the only return.
4) If you’re looking for the bottom of the market there’s a special offer - buy one you get the next one free.

His full article is very interesting:
http://www.wilmott.com/blogs/satyajitdas/index.cfm/2009/1/16/2008--Look-back-in-Horror

His book, "Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives" is a quite informative and a shockingly hilarious read.

I'd add one correllary to #4.
"Early is the new wrong." -Peter Clarke, CEO, Man Group

Fuck...

2009-01-16T01:20:00.000-08:00

a. either the dow is going to go to 3500 or
b. the requisite government bailout is going to make inflation and taxes feel like it did.

???

2009-01-14T00:10:00.001-08:00

I'm not sure what the implications of this are, but it certainly looks dramatic. Treasuries are US Government Debt. Agencies refers to the debt of Freddie and Fannie.

Tobin's q

2009-01-13T23:30:00.000-08:00

"Tobin's q" is a ratio between:

The Market Value of a Company determined by the price of its Stocks and Bonds
and
The present Cost to replace this company's Assets (such as its factories, etc.)

If we calculate this value for the entire stock market (excluding Financial Companies) over the last 110 years, it looks like this:

When the ratio is below zero, it would cost more to create a company anew than to buy an existing company on the stock market. In Bull markets, Tobin's q is above zero, due to the "greater fool" principle. In Bear markets, Tobin's q is below zero, do to the "holy shit!" principle.

This is the most facile portrait of what's going on these days in the Economy

2009-01-12T20:43:00.000-08:00

30 year Fannie Mae mortgage (blue) vs. 30 year Jumbo mortgage (green)

From Greenspan Put 2003 to present...

Close up, from Housing Market Peak 2006 to present...

The Collapse of the Private Equity Ponzi Scheme (Aug 2007)

The Self-Immolation of Bear Stearns (Mar 2008)

The Nationalization of Fanny Mae (July/Aug 2008),

The Destruction/Retreat of the I-Banks (Sept/Oct 2008),

The Beginning of Quantative Easing (Nov/December 2008)

_________________________________________________________________

Economic Indicators against a backdrop of Mortgage Rates

Prime Rate...

5 year portrait of unemployment...

Inflation (Producer's Price Index)

5 year portrait of paper wealth...

To FT Alphaville being the only news source worth its salt, assuming we're talking 15th century salt in the Sahara

2009-01-09T00:02:00.000-08:00

I came across this old article today. It was published (though I hadn't heard of Alphaville at the time) on June 14th, 2007. This was about a week after I quit investment banking and took a job as a carpenter at the Met Opera because I was scared shitless about the future. It was also about the same time as when some idiot Private Equity guys, "Sageview," bought Guitar Center for (I'm not kidding you) $59.99... which just shows they can be suduced by a 99 cent sticker price as much as their average customer.

(I find this Guitar Center leveraged buyout especially precious because it epitomizes the era of cheap credit. This was some deal! Guitar Center, a business whose entire business model is predicated on making 0% interest loans to the least credit worthy segment of the population, "musicians," was bought by Sageview, which payed almost entirely with money they borrowed cheaply themselves!!! Amazing!)

It was also about this time, that my dad, my sister's boyfriend (ex-Goldman Sachs, then Private Equity) and I took a car ride together. We began discussing when we thought the crash would come. "Shit," my dad said, "I just barely broke even to where I was 7 years ago." David, my sister's boyfriend, stated "My colleagues think within 6 months," in his typical diplomatic fashion. "I'm going to apply to business school." I was more equivicable. "As soon as the first big private equity buyout falls through. I don't know. Soon."

Sure enough, six weeks later, financing for the biggest LBO in history, the buyout of Chrysler, fell through. And the turmoil began. "I feel queasy," I wrote to my friend Elizabeth, the morning I read the news. ("This sucker could go down" is what I ment to say)

Anyway, back to the point. On June 14th, 2007 FT Alphaville published this story: http://ftalphaville.ft.com/blog/2007/06/14/5207/you-know-theres-a-bubble-when/
the conclusions of which I will repeat now. (You can read the details yourself.)

You know there's a bubble when:

1) It’s not just Hedge-Fund Guy and his trophy wife demanding splendid isolation from cattle-class rubberneckers eyeing their chocolate-dipped strawberries. Revolution Air, a charter company, will fly more than 20 U.S. kids to summer camp this month, at about $8,000 a hop, the New York Post reported last week.”

2) “You have to get the price right, or it will come back into the market,'’ Hirst told Bloomberg News reporter Linda Sandler. “A lot of people buy things and flip them.'’ You know there’s a bubble when artists are trying to set their prices so high that there won’t be a secondary market for their work.”

3) The zeitgeist-defining product among the free-range bananas, organic spring water and corn-fed soup is a 60-year-old Vecchia Dispensa balsamic vinegar, costing almost $200 for a triangular 100 milliliter bottle stoppered with red wax seals. You know there’s a bubble when an overgrown US chain store can sell antique vinegar to Britons at 32 times the price of Nicolas Feuillatte champagne.” [I swear by their 25 year old vinegar, by the way. Why not? Its the same price as a good crappy bottle of wine and can be used with 50 times as many meals -Matty]

4) It was a rather special chair. Emperor Kangxi graced the gilt-incised brown lacquer throne when he ruled China between 1662 and 1722. Still, Ho could have picked it up for just $43,700 when it sold in 1994 instead of HK$13 million. You know there’s a bubble when a gambling mogul drops a couple of million dollars so that his buttocks can polish the seat of royalty.”

5) “Flip a switch and this feature will maintain your drink’s temperature up to 140 degrees. It can also cool to a refreshingly chilly 35 degrees.'’ You know there’s a bubble when the latest innovation in automotive engineering is a gadget to keep your bucket of Starbucks’ Costa Rica Tarrazu hot enough to guarantee third- degree lap burns when you brake for that road-running child.” [Invented by Chrysler by the way]

6) This week, the philatelist auctioned the set in New York for $9.1 million. “It’s four times profit,'’ Bill Gross said of the price. “It’s better than the stock market.'’ You know there’s a bubble when tiny, lickable portraits of Queen Victoria are a better store of value than stocks or bonds.

7) “The word “bubble'’ has appeared in 94 Bloomberg News headlines this year, up from 40 in the year-earlier period and from 85 in all of 2005. You know there’s a bubble when there’s a bubble in usage of the word “bubble.'’

Happy New Year, everybody!

Oh Time, will you ever cease to beguile me?

2009-01-08T23:26:00.000-08:00

from ft alphaville:

UK interest rates cut to 315-year low

The Bank of England on Thursday urged the Treasury to hasten plans to ease the flow of credit to companies, as it cut official interest rates to a 315-year low of 1.5%. Warning of “an unusually sharp and synchronised downturn” in the global economy, the Bank said it needed to cut interest rates by a further 0.5 percentage points to prevent inflation falling too far for too long. But it stressed that further steps were needed to increase the flow of lending. The government is trying to gather international support for a package to restore funding for bank lending and ease pressures in capital markets.

This entry was posted by Gwen Robinson on Friday, January 9th, 2009 at 5:52 and is filed under Capital markets. Tagged with bank of england.

From the Financial Times: The Year in Review, 2008

2009-01-08T21:51:00.000-08:00

The year in review
By Lionel Barber

There was an ominous fragility about the world in 2008. In mid-September, the financial system came close to collapse. The failure of Lehman Brothers, the 158-year-old Wall Street investment bank, triggered panic in markets. The authorities in New York, Washington, London, Frankfurt and Tokyo looked on helplessly. For a few nerve-wracking days and nights, the world appeared to be hurtling toward financial Armageddon.

The crisis was far from over when another assault on the senses took place, this time in Mumbai. Terrorists, laden with plastic explosives, grenades and assault rifles, killed at least 192 civilians across India’s financial capital and laid waste to the luxury Taj Mahal Palace hotel. By singling out symbols of Indian opulence and power, the perpetrators consciously aped the September 11 terrorists who targeted the Twin Towers in New York.

The Mumbai massacre and the global financial crisis offer a sobering reminder that the path of history is far from linear. No doubt some will be tempted to view the events as a form of divine retribution, a punishment for a generation of excess characterised by a growing gap between the very rich and the rest of us. The twin shocks certainly challenge assumptions which had appeared unassailable since the fall of the Berlin Wall: the innate superiority of the western model of market capitalism and the inevitable progress of globalisation, powered by the free movement of goods, labour, capital and services.

In 2008, as investors rode a switchback in the financial and commodity markets – oil ended the year at about $44 a barrel after reaching an all-time high of $147.27 in July – we witnessed the rise of an alternative model: illiberal capitalism. Authoritarian China has long pursued this path, where the state enjoys a commanding role in the economy. This year, Vladimir Putin’s Russia marched further in that direction, consolidating control over sectors deemed vital to national security, such as energy and commodities. French president Nicolas Sarkozy, irrepressible as ever, put his own Gallic gloss on events when he proclaimed: “Laissez-faire is finished, the all-powerful market that is always right, that’s finished … ”

In the new age of fragility, governments around the world reasserted their role. Sarkozy called for a French sovereign wealth fund to defend leading companies in strategic sectors of the economy. Peter Mandelson, ennobled and restored to the British cabinet after four years of exile in Brussels, called for a new industrial strategy to protect British companies threatened by recession. Asian and Middle East governments or state-sponsored agencies, worried about a sudden surge in food prices, bought up farmland in Africa.

Most striking of all, the US government – like the British government – found itself drawn into advocating a rescue package for the financial sector which had hitherto projected an air of invincibility. By year’s end, the US rescue was headed well above $1 trillion. “This sucker could go down,” warned George W. Bush. His was one of the more memorable utterances of the year – though some wondered whether Bush was referring to the US economy or his ill-starred presidency.

How could the world have arrived at such a humiliating impasse? And why, in the words of Queen Elizabeth II, did none of the experts see it coming? The answer lies in a toxic combination of failures in risk management and regulatory oversight, as well as skewed incentives, particularly in the area of credit derivatives – the sophisticated financial products which dispersed rather than concentrated risk in the system. These systemic failures were compounded by a more basic and familiar weakness: the infinite capacity of human beings living in periods of excess credit to delude themselves into believing that prices will invariably head upward. As one Wall Street chief executive confided to me: “This crisis was nothing more than a gigantic collective bet on the American consumer, sustained by a rising property market.”

In October, the world’s major central banks united in the first ever co-ordinated cut in benchmark interest rates. The cuts kept coming. By December, the US had reduced rates to 1 per cent and the Bank of England had dropped its key rate to 2 percent – the lowest since 1951.

The post-Bubble reckoning is – and will be – severe. Economists warned of a Depression as confidence evaporated in the banking system. The Great Credit Drought, caused by banks hoarding capital, threatened to trigger multiple corporate bankruptcies. The Big Three carmakers in Detroit were given months, if not weeks, to survive. Britain’s high street banks had a near-death experience.

Alistair Darling, chancellor of the exchequer, was excoriated in the summer for warning that the UK faced the most severe economic crisis since 1945. Weeks later, he looked (for once) like a prophet in his own lifetime.

By year’s end, the Brown boom was truly over, with government borrowing set to rise to more than 8 per cent of gross domestic product in 2009. But the Conservative opposition proved curiously ineffectual. The Tories’ considerable lead, at times extending to more than 20 points in the polls, evaporated as a free-spending Brown cast himself improbably as the saviour of Britain – and the world. Europeans, long used to being lectured about the virtues of liberal economics and the supremacy of the City of London, maintained a respectful silence. The notable exception was Angela Merkel, the feisty German chancellor, who preached fiscal probity with the fervour of a Lutheran pastor.

Continental leaders were unable to form a unified front when it came to the credit crunch – a second blow for Europhiles in 2008. The first came when the Irish rejected the Treaty of Lisbon, dashing the hopes of those who had thought the Celtic Tiger’s support for a constitution would bolster the European project.

Amid the pervading gloom, the election of Barack Obama to the White House stood out as a beacon of hope. The first-term senator from Illinois fought a brilliant campaign. He out-organised and outspent Hillary Clinton, the favourite for the Democratic nomination; then he swept aside Senator John McCain, the Vietnam war hero-cum-Washington maverick who fought a lacklustre campaign. McCain’s selection of Sarah Palin as running-mate was typically off-key. Optometrists and much of the US media swooned over the moose-hunting governor of Alaska, but once her barnstorming speech at the Republican convention faded, she turned out to be a seven-day wonder.

Obama’s victory was a moment of great emotion in the US and around the world. Who can forget the shot of the Rev Jesse Jackson, tears rolling down his cheeks, as he waited in the early hours of the morning for the president-elect’s victory address in Grant Park, Chicago? Yet we should not forget McCain’s gracious concession speech, either. November 4 2008 saw American democracy at its best.

Obama’s win drew parallels with Franklin Roosevelt’s election in 1932, but – barring a Depression – a more useful comparison may be with Ronald Reagan’s election in 1980. Then, too, amid deeply troubled economic times, Americans were desperate for a change in leadership. The key will be whether Obama can manage a resurgent Democratic majority in Congress which will be tempted by protectionism and retribution against the once-dominant Republicans.

Inevitably, the Obama victory will be seen as a chance for the US to repair relations with the outside world. America’s image has suffered under the Bush presidency, but most of the damage was done in the first term, especially after the war of choice against Iraq. In the second term, the Bush administration curbed its unilateralist instincts.

In 2008, the stark message was that the threats to US (and western) interests have, if anything, become more pressing: Iran continues to pursue its ambition to acquire nuclear weapons; the Taliban insurgency continues to grow in strength in Afghanistan, drawing in an increasingly fragile Pakistan; and the Israeli-Palestinian conflict remains as intractable as ever. Only Iraq offered a semblance of hope after the US and the Maliki government agreed a timetable for the withdrawal of combat troops by the end of 2011, a recognition that General David Petraeus’s “surge” against militants has been far more successful than the sceptics assumed.

Elsewhere, the US lost ground in the Caucasus when the Russian army invaded Georgia, a pro-western former Soviet republic pressing for membership of Nato. Critics predicted the foray was the opening gambit in a strategy by Vladimir Putin to regain control of former Soviet satellite states. Certainly, it tempered optimism that the “election” of Dmitry Medvedev, a nominally liberal bureaucrat, would signal a shift in Russian policy. The FT interviewed Medvedev in the Kremlin for two hours in late March, and found him a thoughtful advocate of the rule of law. But months later, he looked more and more like Putin’s puppet.

This was not a good year for freedom-lovers, with a few exceptions. July saw the spectacular release of Ingrid Betancourt, the Colombian-French anti-corruption activist held by Farc guerrillas for six-and-a-half years in the Colombian jungle; and two months later, former Bosnian Serb leader Radovan Karadzic was arrested and brought to the Hague to stand trial before the UN war crimes tribunal. The International Criminal Court was also active, with one prosecutor – for better or worse – recommending indicting Omar al-Bashir, president of Sudan, with genocide in Darfur.

But elsewhere, the picture was depressing. Robert Mugabe and his cronies clung to power in Zimbabwe, despite the ravages of hyperinflation. The Democratic Republic of Congo erupted into renewed violence, with casualties in the civil war evoking comparison with the levels reached in Rwanda in 1994. The Chinese cracked down on civil disobedience in Tibet. And pirates became ever bolder on the high seas off Somalia, even hijacking a Saudi supertanker.

If there was light, it came in the spectacular shape of the Beijing Olympics. The opening and closing ceremonies set new standards in pyrotechnics. But there were also memorable sporting performances, notably by the bionic swimmer Michael Phelps and the world’s most graceful athlete, the Jamaican sprinter Usain Bolt, who set world records in the 100m and 200m races and 4 x 100m relay. His trademark golden track shoes and his arched victory pose will linger in the popular imagination, a welcome counterweight to the cynicism which, thanks to the wonders of modern drug laboratories, has long poisoned athletics.

The other winner was Damien Hirst, the post-pop descendant of Andy Warhol, to quote FT critic Jackie Wullschlager. Hirst’s “Beautiful Inside My Head Forever” exhibition contained more than 200 pieces and later fetched £111m in a Sotheby’s auction. The top lot was “The Golden Calf”, a 600kg bullock whose hooves and horns are cast in solid 18-carat gold. It sold for £10.3m, a record for the artist at auction.

The sums are breathtaking, but in retrospect they may be seen as the last gasp of an era of excess. Last month, it was reported that Hirst, who is worth more than £200m, had laid off 17 of the artists who help produce his work. One of the directors of his art production company said: “We have to be mindful of the current economic climate and how this might affect us in the future.”

The year 2009 will be altogether more testing for those at the top as well as the bottom of society.

Lionel Barber is editor of the FT.
Copyright The Financial Times Limited 2009

2009-01-03T01:34:00.000-08:00

Los Angeles is heavy. You can see to the ends of the earth and there's nowhere further to go.

New York is stressed out. People are angry. Two of my friends, both gentle and intelligent, and I all independently, got into altercations tonight. I demarcate myself, because I was the antagonist in my tussle.

I am a little stressed out with nostalgia for the future. That is the way to be, but I'm not quite right. I am melancholic for the future. and that is the worst way to be.

Melancholia implies a depression. Nostalgia implies a haze. but possibly a fiery haze.

I don't mean to be a beatnik, but Proper Valuation is mystical. It derives from, and makes sole reference to, The ratios and their harmonics.

..........

Pillow Talk

2008-12-26T18:25:00.000-08:00

So 'Pillow Talk' is the best movie of all time. Though I’m working my way through 'Baby Boom.' And of course all I know about finance I learned from 'Working Girl' and 'How to Succeed in Business Without Really Trying.'

On this day after Christmas, 2008 I wanted to give a shout out to the world’s oldest profession. Jezebel.com, where my fiancée Sadie Stein works, has a sister site, Fleshbot.com, a porn aggregating site… which is a fancy way of saying they do the dirty work for you. They turned me on to Faye Reagan.

I believe she is from the future, or the very distant past.

Finally, I’ve decided to retire and become an artistic nude photographer. Petre Hegre, has been my idol for many years. [Though beautyisdivine.com, mplstudos.com, retroraunch.com and www.met-art.com deserve honorable mention for doing the best they can with limited vision.]

I never thought I’d be a good artistic nude photographer but Sadie, my fiancée, has really encouraged me to follow my bliss, and has been a constant source of strength in my early nude pursuits.

Happy Christmas. And as they say in Ireland, Merry New Year.

And if you want to share some holiday spirit by buying me a gift, here's my wishlist:
- grabit drill bit 800.385.4985
- gold Indian 800.841.3469

Milan Kundera

2008-12-10T04:14:00.000-08:00

Ever heard of Czech modern? Communist lounge?
Well there's one guy in Dumbo doing it.
Can we corner the market in Hungarian... or after the currency peg collapses, Romanian modern..? Yes, we can.

Lube in Contango

2008-12-10T04:11:00.001-08:00

After the gold rush...

2008-12-06T14:15:00.000-08:00

On Fri, Dec 5, 2008 at 9:45 AM, michael vanreusel wrote:
Matt,
Did you see the employment report? Looks like we are entering great depression part 2.
Michael

Dear Michael,
Lets look at this in prospectis:

Base metals:
With the exception of Tin, which I believe is still in a bull market, the majority of base metals (zinc and lead particularly) are essentially at their 20th-century lows, inflation adjusted, of 1919 and 1930. So essentially any positive growth would be inflationary for these metals. In precious metals, the gold to silver ratio is extremely high, suggesting that if we end up in a highly inflationary environment, silver should out-perform. Rhodium was $11,000 and now is around $1000. This should do well long term if we get fair weather or stagflation.

Agriculture:
Our stocks of wheat are at their lowest in decades yet the price (inflation adjusted) is at its lowest ever excepting the range from 1995-2005. Broad agriculture exposure to the physical commodities from ETNs like RJA or the DJAIG indexes is desirable. A small equity exposure to producers of fertilizer and genetically modified seed could be applied as a kicker.

Bonds:
Brazilian 10-year government bonds (at 17%) and 10-year TIPS (at a negative 1% yield) looks like bargains. A mixture of investment grade and junk bonds looks attractive, as the junk bonds are pricing in a 50% default rate (about a 20% yield) and investment quality corporates are yielding 7-9%. (The default rate on junk bonds was 30% at the height of the Depression) If you’re feeling a little footloose, Tata Motors just got permission to take deposits and has set up savings accounts in rupees paying 11%.

Shipping:
The thing with the most to gain (besides physically holding rhodium for a long, long time) is Paragon Shipping. [Nasdaq:PRGN] Paragon Shipping (with 12 dry goods ships in three different sizes) has a current liability to current asset ratio of 50%, and just announced share buybacks. Long term liabilities to assets are at 58%. Its trading at $3.85 and had earnings per share of ~$2.48 in the third quarter. Their earnings will obviously be terrible in Q4. It has mostly 1-2 year staggered time charters and a few ships on spot. The chart looks extremely good as long as the Baltic Dry index of spot shipping rates (which has plummeted 93%) doesn’t vanish from the face of the earth and the world economy collapse entirely. I would like to think that a majority of the pressures on the Baltic Dry are due to problems obtaining letters of credit. If so, this sector should lead any recovery in the markets overall. Furthermore, banks will forgo their traditional role as buglers for the bull recovery due to increased regulatory pressures. As such, shipping companies provide a unique transmission channel to gain exposure to a recovery in the commercial paper and asset-backed markets without exposure to toxic assets.

Art:
Mark Rothko is off 25% this year and he’s swell. I think late 1970s through early 1990s Sam Francis and David Hockney prints are exceptionally cheap right now. I’m trying to get Damien Hirst to make a pencil with a gold center for me.

I think artprice.com [Euronext:PRC] (down 75%) is a great “what the hell” kind of play. It revenues are growing every year (and profits falling) and it has virtually no analyst coverage in the US. I find the site extremely useful. Its trading at $5 dollars vs. its IPO two years ago around $20.

Equities (Macro):
Starting in the spring, with a super long term macro view, I would buy the stocks of companies in India, Brazil, and Finland.
One: because they all make beautiful music.
Two: because their women are incredibly attractive.
And three: because their educational rankings are good on average.

I also believe these three together, comprise a very balanced ex-US equity portfolio: Brazil and India are two emerging markets with two completely different economies. Brazil exports commodities and India imports them, exporting services instead. Finland is a highly developed economy with good social services (reducing cost to businesses) and a cultural memory of design and innovation.

I believe someone who desires additional equity exposure, could further diversify with a Pan-Sub-Saharan Africa ETF. After my recent visit to Buffalo, NY where people were not overly concerned about the economic collapse and where real estate just rose 3% year on year, I have become convinced that the optimism and trust engendered and inculcated by shared sacrifice is an essential component to equity portfolios in a time where most of the developed world is frozen in indecision fomented by distrust and fear.

Real Estate:
I would definitely buy a craftsman house in Vallejo, CA immediately. And real estate in New York within 18-36 months. Probably sooner for distressed bargains in the high-end market, and later for bargains in the middle and lower-end.

Oil:
This is obviously a big story in the medium long term but its extreme price ranges over the last 40 years makes me totally unable to predict its path in the near term. That being said, it is at the same price as in its peaks in 1990 and 2000 (inflation adjusted). This should provide strong price resistance given the large amount of demand which came online in the past 20 years and the current production declines from existing oil fields. I would hedge oil exposure with stockpiles of kerosene and AK-47s in case of a true deflationary meltdown. I really like your black swan style-call option-bird flu-stockpile idea.

Sport:
Finally, I've got 20 bucks riding on Manny Pacquiao in the Oscar de la Hoya fight, because of his trainer Freddie Roach and for the reasons listed in these two LA Times articles:

http://www.latimes.com/sports/printedition/la-sp-dwyre6-2008dec06,0,4193360.column
http://www.latimes.com/sports/printedition/la-sp-dwyre3-2008dec03,0,1834058.column

I'm gonna post this on my blog today, and try to upload some pictures of the charts in the next few days. Check it out next week.

Take care,
Matty Talty Colvard

We teach what we cannot learn.

2008-11-21T14:48:00.000-08:00

A "friendly experiencer" in the markets, makes his decisions amidst the deluge of sights, soundbits, and combating opinions from other experiencers market-wide. Often times our convictions are proved wrong, and when we get burned, we learn not to touch the fire. But if we're all future-blind, how are we to know the incendiary agent? We may prepare ourselves against fire, only to be scalded by a bursting steampipe. Worse, in our blindness, we may mistake the scald for a burn and learn nothing.

And so we often learn the wrong lessons, mistaking causality or blaming our own tactics. But the most malicious lesson, is the one we make when we have been burned so many times that our nerves have been seared off. We cease to be able to feel. In our numbness, we abdicate our responsibility to prepare for the next conflagration.

Today the stock market fell back 11 years in time, briefly touching a number near which Alan Greenspan gave his infamous "irrational exuberance" speech. In 1997, Greenspan was worried about the excessive valuations in the stock market. He decided to raise interest rates. The market fell 7% and then roared back. Greenspan writes, "It recouped all of its losses and gained 10 percent more, so that by mid-June, it was nearing 7,800. In effect, investors were teaching the Fed a lesson. Bob Rubin was right: you can't tell when a market is overvalued, and you can't fight market forces."

This was precisely the wrong lesson to learn. Lets review what Greenspan said in his infamous speech:

"As we move into the 21st century... one factor will continue to complicate [the] task of pinning down the notion of what constitutes a stable general price level... Where do we draw the line on what prices matter? Certainly prices of goods and services now being produced - our basic measure of inflation - matter. But what about futures prices? Or more importantly, prices of claims on future goods and services, like equities, real estate, or other earning assets? Is stability of these prices essential to the stability of the economy... How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions... and how do we factor that assessment into monetary policy?... We should not underestimate, or become complacent about, the complexity of the interactions of asset markets and the economy."

And so after Greenspan's puny stand against asset prices (he raised interest rates 0.25%) he threw his hands in the air and abdicated all responsibility for counter-cyclical tightening, with grave consequences for us and the stability of the world economy.

He will be remembered for illustrating what he could not perform.

And for teaching what he could not learn.

Make-A-Wish Foundation Rings Opening Bell, Tanks Stocks. Seismic Collapse in Bond Market Yields Benefits Non-Profits Everywhere. Quantitative Easing!

2008-11-20T13:47:00.001-08:00

The Make-A-Wish foundation destroyed the stock market today. Charity is even more out of style than clowns and Kiss.

This is ironic because a properly run foundation should have the majority of their investments in bonds. Well lets hope they do because the entire yield curve collapsed to below the rates where the Treasury has ever issued bonds. Assuming Make-A-Wish is properly run, they racked up massive gains today as the collapse in Treasury rates make their bond holdings extremely profitable.

As the market moves to price in quantitative easing, banks are aggressively hedging their exposure to the bond swap market, in which they have guaranteed long term rates for borrowers. This has kept swap rates below the bonds they're linked to... previously considered to be a mathematical impossibility. This is because banks normally charge a premium over the market rate on bonds to compensate them for the long term risk they're taking on.

Let's review the Bernanke playbook for conducting monetary policy in a zero Federal Funds rate environment which we spoke about a week and a half ago.

1) Take the Federal Funds rate to zero. Check.

2) Lower the rates on long term (5-30 year) bonds, by either promising to keep short term rates low for a number of years or commit to make unlimited purchases of long term bonds until their interest rate falls. Check.

3) Push down interest rates on private securities by buying them as well. Check for Commercial Paper (short term debt) Not much impact on long term corporate bonds, unfortunately.

4) Intervene in the Foreign Exchange market to weaken the dollar and raise the price of imports. No action yet.

5) Coordinated easing of both monetary and fiscal policy, for example tax cuts financed by issuing money so there is no increase in government debt. Check, sort of.

So it appears the majority of their gunpowder remains only in Foreign Exchange intervention. This is an extremely politically sensitive measure and is unlikely to be implemented except as a last resort.

But what is truly shocking about this whole thing is that the Fed has not come out to announce these courses of action. Very strange for a Fed that prides themselves on transparency.

Opening Bell

2008-11-19T23:01:00.001-08:00

Last Friday, clowns from the "Big Apple Circus" rang the opening bell. The Dow fell 403 points.

Today, Gene "The Street Giveth, and the Street Taketh Away" Simmons rang the opening bell. The Dow fell 517 points.

Tomorrow, the Make-A-Wish foundation will ring the bell. Frankly, this is getting a bit ridiculous.

Oddly disconcerting clips:
Clowns

Kiss

The (un)Thinkable is happening. Panic now. Thankfully we have the Bernanke Experimental Economics Playbook

2008-11-10T16:24:00.000-08:00

Vol. 1: "Soft Landings..."

Dr. Ben Bernanke, in a speech on November 21, 2002 laid out a playbook of options for the Federal Reserve to run should it ever lose control of monetary policy in the face of massive deflation. Intended primarily as a thought experiment, this graph shows the Fed losing control as we speak. Witness the (relative) stability of the federal funds rate until the bankruptcy of Lehman Brothers and the reverse take-under of A.I.G.. Up until today, the effective federal funds rate has never approached its zero limit... never-ever.

We are truly balancing on the edge of economic science and there is no chart for where we are going. This is a Ph.d level, alchemy lab improvisation called "Quantitative Easing." The Federal Reserve is synthesizing a powerful medicine, but they don't know if they're missing an ingredient, and they have no idea what size dose to give. To much and the patient will OD chasing the inflation dragon. To little and he'll go into cardiac arrest.

Click here to understand what I'm talking about.

And here to read "The Unthinkable Has Happened" by Tracy Alloway, Ftalphaville.ft.com

And here to read "Obama Can Be a Roosevelt, Not a Carter" by David Blake, Ft.com

Go Long, Karl Popper

2008-11-10T12:36:00.000-08:00

Reading a biography of Karl Popper today I was struck by this quote:

"Popper regarded democracy as the only political system capable of institutionalizing knowledge and freedom, and since he regarded the latter as a condition for the former, it may be said - though he might not say it - that history had proved him right. The fallibility of the democracies had turned out to be a strength; the infallibility of dictators had revealed their weakness. Totalitarian systems created an illusion of frictionless cohesion and inflexible unanimity, but - by damning all dissent as treachery - such regimes lost any prospect of improvement or self-correction through constructive criticism."

Applying this concept to the stock market, I think this is the strongest argument in favor of allowing short selling I've ever heard.

The Gaussian Fallacy and Other Epistomological Failings in the Age of the (Aging) Bullshit Baby-Boomer

2008-11-03T16:45:00.000-08:00

I've typically been skeptical of adherents to Nassim Taleb's "Black Swan" club. The events that have unfolded since the collapse of the Chrysler deal in late July 2007, are not black swan outcomes. [No one posited the existence of black swans. All swans were white, until they weren't.]

These outcomes are the wholly predictable results (in framework, if not in detail) of the moral bankruptcy of the Baby-Boomers and Generation X coupled with an unsustainable and untenable financial system. I believe there were extremely few people in the world who believed we could save nothing and borrow money at 0% forever without the bill ever coming due.

However, I think that this very lucid post on Ultimi Barbarorum (a Spinozist blog about finance) is an excellent summary of the ways in which financial innovation abetted the stability of the system for the first half of this decade until it didn't.

The only thing I would add, is that retail investors were also tricked by a Gaussian Fallacy. They were told that stock returns followed a Gaussian distribution... as long as you diversified, never paniced, and invested in low cost stock index funds, you could expect 10% a year and retire happy. This shiny ordure was sold to our parents by men under fifty who had begun their careers after 1980 and had never seen anything but a stock bull market. The ideological laziness and lack of intellectual curiosity on the part of our parents and their financial advisers is inexcusable. The "this time its different" argument, used to explain why it is not important to study the past, is the direct consequence of the self-indulgence, egoism, and narcissism of the Baby-Boomers and Generation X, both of whom were raised or came to believe that they were "special" and somehow their history would be as well.

With compassion for their sins, I nevertheless look forward to the rottenness being purged from the system. As a child I used to think a good name for my generation would be "Generation Why" but more and more as I become an adult I believe in Generation MGMT.

Synopsis:

2008-10-23T10:29:00.000-07:00

"Banks would normally be wary of lending to someone whose liabilities were 50 times their net assets, but they happily lent to each other on that basis - until, one day, they stopped. If you want a one sentence explanation of the present crisis, that is it.

In business, capital is the stuff you have - to protect yourself, your customers and your creditors - when things go wrong. In good times, you may feel you do not need it and may resent paying for it. In bad times, you can never have enough. If you do not have it already you will find it very expensive or impossible to obtain. You may then go broke. If you want a one paragraph explanation of the capitalist system, that is it."
- John Kay, FT

Distressed Assets

2008-10-19T16:30:00.000-07:00

I just bought the book, "Distressed Debt Analysis: Strategies for Speculative Investors" for 10 cents on the dollar. The person coding the bar code scanner must of labeled it wrong, but there was no way for the salesperson to verify it since the was no price on the book, only a bar code. Based on this transaction, I may not read the book, since I think I just mastered the material.

Quote of the Century

2008-10-19T12:19:00.000-07:00

“…public credit depends on public confidence…The financial crisis in America is really a moral crisis, caused by the series of proofs …that the leading financiers who control banks, trust companies and industrial corporations are often imprudent, and not seldom dishonest. They have mismanaged…funds and used them freely for speculative purposes. Hence the alarm of depositors and a general collapse of credit…”
-The Economist, November 2, 1907

Quote of the Day

2008-10-19T12:03:00.000-07:00

"Markets remain gloomy. They are waiting anxiously for “the shoes to fall”, except it seems that the shoes are from Imelda Marcos’ collection."

-Satyajit Das, author of the brilliant and funny, "Traders, Guns, and Money: Knowns and Unknowns in the Dazzling World of Derivatives"

Quote of Yesteryear:
Me (in the business section of B&N): "I'm looking for a book by Das."
Hipster Clerk: "Ram Das?"
Me: "No, not frigging 'Be Here Now', its a book on derivatives. You should read it, we're all about to be nowhere."

The Long View... 1885-2008

2008-10-19T10:36:00.001-07:00

Click to enlarge:

As you can see from the chart above, the Dow Jones Industrial Average (inflation adjusted) peaked at ~5000 in 1929 and ~7000 in 1966. Which makes last week's trading range between 8000-9000 either the most tremendous buying opportunity in the last 15 years or a terrifying look into the ravages of deflation. You will also notice that it takes on average 14 years for these massive troughs in the cycle to right themselves again. The DJIA often stays flat for around 28 years (for example see 1890-1911, 1900-26, 1926–56 and 1966-96). I figure we are about halfway through the current cycle.

I believe in human progress, and the science of economic theory and crisis management has evolved quite a bit in the last hundred years. The key question however is this: Which expertise has evolved farther, our ability to solve economic crisis, or our ability to create them?

Living in Clip

2008-10-15T23:51:00.000-07:00

Imagine credit is the world's largest, loudest, most awesome guitar amplifier and we've just blown almost all of the speakers. When you overdrive an amplifier it heats up and this heat makes it more difficult for the amplifier to handle a large burst of energy (Think of the bankrupcy of Lehman Brothers.) When this happens, the amplifier cannot reproduce the signal and clips, sending the burst of energy to the speaker which blows up the speaker coil.

The repo market is living in clip right now. In this tightly coupled market of lending between institutions, one failed trade can cascade through the system causing massive counterparty failures. On Tuesday a record 2.290 trillion dollars worth of trades failed. Borrowing rates on loans backed by U.S. Treasuries are stuck near zero percent, suggesting that despite the offer of free money, no bank is willing to part with their holdings of government debt which is crucially necessary for them to hold as collateral to ensure their solvency. The Ted spread, a measure of the difference in borrowing costs between interbank loans and loans directly from the government is stuck at historic highs, as banks hoard capital and refuse to lend for more than an extremely short duration.

As this clip ripples through the system it is rapidly destroying crucial cogs in the machine. This more than any other factor is what has contributed to the massive collapse in paper and tangible assets as fears of deflation lead to widespread discounting in the prices of all assets. Despite an easing in the credit default swap market on the risk premium for financial companies, we can not even hope for a bear market rally until some semblance of trust is restored.

Farmer's Almanac: 2009

2008-10-15T23:33:00.000-07:00

Low-quality Robusta coffee prices have tumbled as exporters struggle to obtain financing. At these prices ($o.06/lb in Indonesia - $0.93/lb in London) millions of farmers are suffering and have begun to remove their product from the market rather than face steep losses. Exporters are halting shipments until prices recover. "We are effectively slitting our throat at these prices," said Hasan Widjaja, chairman of the Indonesian Coffee Exporters Association.

Farmers, burdened by heavy debt they incurred during last spring's highly inflated fertilizer purchases will go bust. Failures in agriculture may lead to an explosion of inflation next year.

In 1929 the Dow Peaked at 4893

2008-10-10T19:58:00.000-07:00

(Inflation Adjusted)

1966

2008-10-07T16:11:00.000-07:00

So, regarding the very real, but still unlikely prospect that the Dow could fall back to the year 1966, (it peaked then at 6900 points versus 9400 today)... how good of an economic indicator is the stock market? Has there been any real and inalienable increase in wealth since 1966?

["Wealth is the number of days you could sustain your lifestyle if you were to stop working today"- Buckminster Fuller]

Or is the stock market only an indicator of credit availability, that is, leverage and a unassailable trust in future wealth creation?

Rally like its 1999...

2008-10-06T21:31:00.000-07:00

Some quick back of the envelope calculations... If you took out a CD yesterday at 3.5% and invested an equal amount of money in the stock market at the same time... your losses today in stocks equal all of the interest you could hope to accrue in the next year from your "safe" certificate of deposit.

Touching 9300, a level its not seen since 1996, 1997, 2001, or 2003, the stock market is now ready to rally like its 1999.

(Unless it hits 7000 in which case we're back to 1966)

Why?...

I am beginning to feel pessimistic for the first time since Bear Sterns was rescued. Judging by the capitulation factor, this means I am wrong, since I am the most pessimistic guy out there. I was amongst the first to feel worried back when the Chrysler deal collapsed in the last week of July, 2007. But, I've been optimistic ever since Bernanke began to bend the rules this last March. . .If I am capitulating than we must have reached the bottom.

However the volume, the amount of trades done in a given day, has been extremely low ("dull"). This make me nervous.

Normally in a bear market, the situation is as Joseph Granville (see footnote) describes it, "Volume will be light on the early stage of the decline because the public believes that the decline is nothing more than one of the usual previous dips in the bull market and the result they expect will be another buying opportunity. The early selling is therefore done by the professionals. When the decline does not stop, the public becomes concerned and starts to sell stocks and the volume gradually rises on the accelerating decline.

As the decline becomes more rapid, the public gets more and more frightened and now stock are being dumped. This sends the volume still higher and a 'selling climax' results.

Recognizing this climax as a sign for a technical rebound in the market, the professionals start buying and the market goes into a technical rebound.

If the fundamental business background is showing some signs of weakening at this juncture, then such a rebound in the market would probably be considered as a selling opportunity, further declines are yet to come. This pattern can be summarized as: First phase of the decline on light volume- professionals are selling, and the public remains confident. Second phase of decline on heavier volume- professionals are selling, public disbelief over the decline causes them to lighten up. Third phase of decline on still heavier volume, leading to a selling climax- professionals finish their selling, and public confidence, now shaken, bring in a deluge of stocks. Fourth phase of decline- temporary technical rebound on professional short covering and general professional buying while the public continues to sell."

But I believe these rebounds have already happened in September 2007, April/May, and July/August of 2008.

"H.M. Gartley was a great technician in the 1930s. He did more work on volume than any other man. In 1933, he wrote:

'Bear market cycles begin on reduced volume. As the major (downward) phase develops, volume increases and this phase ends in a selling climax on heavy volume [March 18th 2008, July 15th 2008] The ensuing rally (corrective phase) is accomplished by declining volume, which dwindles until the rally loses momentum completely, and the major trend is resumed in a new bear cycle... Bear market rallies start out of active selling climaxes.'

Note that the first six bear market rallies, following the 1929 top, came out of heavy trading. But the rally in July 1932 came out of extreme dullness, indicative of a major reversal (a new bull market began on July 8, 1932 [granted it was down 90% from its peak]). The rationale behind the diminishing volume in bear markets is simply that the public loses interest as it loses money. Also, they have less capital to trade with, owing to those losses."
-Harry D. Schultz, "Bear Market Investing Strategies" 1968, revised 2002.

I think the difference between a crash today, or the crash of 1929 is the the government is coping with rather than exacerbating the crisis. So perhaps we will not have six bear market rallies, but more likely 4 or 5. We already had one in September 2007, April/May 2008, and August/September 2008, so maybe one more rally now and another in 9 months or so.

Or we will have six or more rallies but they will be not from declines like 1929-1932 but more like the gradual troughs of the 1970s. Basically the picture I see in my mind is the Federal Reserve, like a machine, trying to damp the vibrations of a violently oscillating string. In this picture the each fall and rally gets less dramatic as the crisis is solved.

Here is the reason why the crisis is not solved... Consumption is 70% of our 13 trillion GDP, about 9 trillion dollars. When a store takes on inventory, or in the service sector, borrows to meet its payroll in advance of its receipts, the store borrows in the commercial paper market. Doing an extremely crude back-of-the-envelope calculation, lets say half of that 9 trillion dollars needs to be borrowed every year to finance the goods we consume.

If this is averaged over 12 months, 375 billion dollars needs to be borrowed by companies, short term, every month. Right now this market is entirely shut down. (Quick check of the facts, the commercial paper market is actually 1.6 trillion dollars per week, because corporation evidently borrow more than I thought possible and it also includes bank's short term financing requirements, which I did not consider.)

"The Federal Reserve is working with the US Treasury on plans for a dramatic move into unsecured lending in the hope that this extreme step could help bring credit markets back to life.

As well as unsecured lending to banks, this could lead to the Fed directly purchasing commercial paper or funding a special purpose vehicle set up to do this.

Any unsecured lending would be a radical departure for the Fed. Central banks almost never make unsecured loans, and the Fed has never done so in its history...

It would allow the Fed to address two key problems in the financial system directly: the freezing of the term interbank money market, which covers all but overnight borrowing, and the rapid contraction of the commercial paper market...

The core of the problem in the interbank market is the lack of availability of term unsecured loans. Banks can get some term funding, but only on a collateralised basis, which helps explain the extreme demand for Treasury securities used for collateral purposes. Unsecured borrowing rates for any significant period of time - such as the three-month Libor (London interbank offered rate) - are sky high. In practice, most financial institutions are now unable to get term loans without collateral, and are funding themselves heavily in the overnight market." -Ft.com

"This hurts banks. Most [bonds/revolving lines of credit] are three- to five-year deals, agreed pre-crunch, at rates - typically Libor [pre-crisis, LIBOR was Prime minus 3%] plus six to 10 basis points for an investment-grade credit - that now seem extraordinary. Back then, these were barely break-even deals for the banks: they'd use them as a ticket to an M&A mandate or a big interest rate swaps programme. Now banks are funding themselves at much wider spreads. Whether they recover the notional amount is almost irrelevant - a drawn-down revolver means net interest margins are shot to pieces." -Ft.com

"This reliance on overnight money is dangerous for the financial system. It makes banks vulnerable to short-term market dislocations or loss of confidence, increasing the likelihood of failures and firesales of assets.

There are two reasons why banks cannot obtain term unsecured loans from the private market. There is a classic financial-crisis coordination problem, characterized as: "I won't lend you money for a month if I think that everyone else will only lend you money for a day, allowing them to pull out tomorrow and leave me stranded." This "roll-over" risk is a form of liquidity risk. The second reason is the credit risk of lending to banks, which has been elevated by the financial and economic turmoil.

The Fed's existing liquidity operations - ramped up again yesterday - reduce liquidity risk by providing a large backstop source of funds. But they are imperfect substitutes for unsecured borrowing, as they are only available on a secured basis. Unsecured term loans - for instance at 100 or 150 basis points over the federal funds rate for three-month money - would provide a near-perfect substitute.

The unsecured Fed term loan rate would act as a ceiling for Libor. Banks would be able to use these loans to reduce their reliance on overnight borrowing, making the system more stable.

Moreover, banks would in theory become more willing to lend spare funds to each other, reviving the private interbank market, since the borrower or lender could turn to the Fed for unsecured loans if it suddenly needed additional liquidity."-Ft.com

It is extremely dangerous to call market bottoms, but this unprecedented move by the Federal Reserve is almost the last trick in their hat. They have also announced they will start paying interest on overnight bank deposits with the Federal Government. This (which the European Central Bank already does) will allow the Fed to much more closely manage overnight borrowing rates. If this doesn't work, nothing else will. I suggest putting half of your money in the mattress and buying stocks with the other half.

For the folly of calling market tops, see the footnote on Joseph Granville below...

[Granville is probably best known for his bearish market calls during the 1970s, 1980s, and 1990s, when he claimed that the stock market was headed for imminent collapse. His overall track record, according to the Hulbert Financial Digest, is very poor.

The Granville Market Letter "is at the bottom of the Hulbert Financial Digest's rankings for performance over the past 25 years - having produced average losses of more than 20 percent per year on an annualized basis." ^[3]

Nevertheless Granville was known as a great showman ^[4] who would emerge from a coffin at an investment conference, or appear to walk across water (at a swimming pool) when meeting clients. According to Robert Shiller in his book Irrational Exuberance^[5]

His investment seminars were bizarre extravaganzas, sometimes featuring a trained chimpanzee would could play Granville's theme song "The Bagholder's Blues," on piano. He once showed up at an investment seminar dressed as Moses, wearing a crown and carrying tablets. Granville made extravagant claims about his forecasting ability. He said he could predict earthquakes and once claimed to have predicted six of the past seven major world quakes. He was quoted by TIME Magazine as saying "I don't think that I will ever make a serious mistake in the stock market for the rest of my life," and he predicted that he would win the Nobel Prize in economics. -Wikipedia]

Bullish...

2008-10-01T14:09:00.000-07:00

The New York Times reported in the Sunday Times this weekend that a bull escaped from its pen and ran wild through the streets of Queens. While there is not much precedent to give this event credence as a contrarian indicator, it is worth examining some of the factors that may result in a stock rally for the next few months. No less an authority than Marc Faber, a fund manager so bearish that he is often referred to by his nickname, Dr. Doom, thinks a rally is imminent. He writes,

"What is important to understand is that equity markets have become extremely oversold, that sentiment is very negative - almost a panic - and that equity markets usually bottom out from a seasonal point of view between the end of September and early November. Markets may have put in a low yesterday and could rally into March of next year. But such a rally will not be the beginning of a new bull market but a bear market rally, which will be followed by further price declines - certainly in real terms - as the global economy contracts and as corporate profits disappoint badly. The credit bubble has burst for good and central banks' easy money policies and large fiscal deficits will be unable to re-ignite credit and economic growth. Between 2001 and 2007 we had a global synchronized economic boom and a bubble in all asset classes including real estate, equities, commodities, art, worthless collectibles, and even bond prices. Now a global bust will follow with all asset prices deflating one after another like a falling domino."

I would add to this four things. Baron Rothschild once extolled the virtue of buying when there is "blood on the streets." In the last week I have heard everyone from the extremely rich parents of a friend of mine, to my union colleagues at the Metropolitan Opera house wondering if it is finally time to give up on equities. Secondly, yesterday I overheard a shopkeeper in Brooklyn worrying about deflation; highly unusual considering his costumers' complaints about high prices all year. Thirdly, since 1888 the Dow Jones Industrial Average has risen 4.34% on average from October through December in a presidential election year. This has occurred in 21 of the 30 election years. And finally, the Dow failed to break 10,000; a very important psychological level not just for stock investors but for the American public at large.

While none of these musings is remotely scientific, I would like to mention that the stock market appears to be the only market in the world where people typically buy when prices are high and sell when prices are low. It makes no sense to wait until some Abbie Hoffman-esque character releases a bull in lower Manhattan for more of a signal to begin bargain hunting.

Oh no...

2008-09-30T21:25:00.000-07:00

Ebay Whip Inflation Now intervention fails! Dow rises 600 points!

Ketchup Soup

2008-09-29T14:40:00.000-07:00

1.2 Trillion Dollars vanished from our imagination here in the United States, and we moved four years back in time. The S&P 500 had the biggest percentage loss since October 1987. The Vix (Fear Gauge) hit a level that has only been seen in 1987, the Russian Default of 1998, and the aftermath of the 9/11 attacks.

Campbell Soup was the only stock in the S&P 500 which gained today. But, if we are really in the worst crisis since the Great Depression, shouldn't this be the worst performer?

This is deeply disturbing. Either everything is going to be okay, or we should all go out and enter a spread: shorting Campbell soup and buying some second-tier ketchup like Hunts.

By the way, the Ebay Whip-Inflation-Now Indicator is flashing high alert as it hit 100% unconcerned about the prospects for inflation. At zero bids, Ebay W.I.N. Indicator is signalling crisis level fears of imminent depression. I may have to intervene in the market.

Reflections on Today, from Henry Clews, 1908.

2008-09-27T12:37:00.001-07:00

"The action of commerce, like the motion of the sea or the atmosphere, follows an undulatory line. First comes an ascending wave of activity and rising prices; next, when prices have risen to a point that checks demand, comes a period of hesitation and caution; then, care among lenders and discounters [or not -ed.]; then comes the descending movement, in which holders simultaneously endeavor to realize, thereby accelerating a general fall in prices. Credit then becomes more sensitive and is contracted; transactions are diminished; losses are incurred through the depreciation of property, and finally the ordeal becomes so severe to the debtor class that forcible liquidation has to be adopted , and insolvent firms and institutions must be wound up. This process is a periodical experience in every country; and the extent of the destructiveness of the crisis that attends it depends chiefly on the steadiness and conservatism of the business methods in each particular community affected. In addition to this ordinary and, I would even say, natural liability to commercial crises with a greater or lesser degree of panic, we, in the United States, have to stand the far more violent oscillations so inseparable from our great mass of new and immature undertakings.

In times of crisis, the obligations issued against such enterprises suffer instantly from the uncertainty about their intrinsic value. Holders are anxious to get rid of them; banks which have advanced money on them, call in their advances; and they became virtually unavailable assets...

In view of the facts, what is the use of discussing the possibility of averting our periodic panics? Risks and panics are inseparable from out vast pioneering enterprise; and all we can hope is, that they may diminish in severity in proportion as our older and more consolidated interests afford an increasing power of resistance to their operation. I am disposed to think that, in the future, the counteraction from this source will be much more effective than it has been in the past...

But, whilst maintaining that panics cannot be avoided in a country situated as ours is in its present incomplete development, I cannot avoid expressing the opinion that conditions are permitted to exist which needlessly aggravate the perils of these upheavals when they do occur. In every panic much depends upon the prudence and self-control of the money lenders. If they lose their heads and indiscriminately refuse to lend, or lend to only the few unquestionably strong borrowers, the worst forms of panic ensue; if they accommodate to their fullest ability the larger and reasonably safe class of borrowers, the latter may be relied on to protect that whom the banks reject, and thus the mischief may be kept with in legitimate bounds. Everything depends upon rashness being held in check by an assurance that deserving debtors will be protected. This is tantamount to saying that all depends on the calmness and wisdom of the banks...

These periods of the breaking-down of unsound enterprises and of the weeding out of insolvent debtors and of liquidation of bad debts can never be wholly averted; nor is it desirable that they should, for they are essential to the maintenance of a sound and wholesome condition of business; but it is a grave reproach to our legislators if, when the day of purgation comes, the law treats the deserving and the undeserving with equal severity."

-"Fifty Years in Wall Street," Chapter 10 PANICS-THEIR CAUSES-HOW FAR PREVENTABLE, Henry Clews, 1908

One way bets... Vallejo, CA

2008-09-27T09:54:00.001-07:00

Amidst a financial crisis of the worst kind, let's put things in perspective. For at least a decade, my fiancee's grandfather, Grampa Moe, was convinced that the "bad times" were coming. He prepared for one scenario, a repeat of the Great Depression. This required land, a house, several watercraft, 30 pressure cookers and ample stockpiles of gold and silver. In light of recent events, this seems extraordinarily prescient. If he were alive today (he got tired and frustrated waiting so long for it to happen) he would tremendously enjoy his vindication and his transformation in his family's eyes from eccentric to genius.

But history will not repeat the past because we have in our employ Chairman Ben Bernanke, the foremost scholar on the Great Depression, and possibly the most creative, trenchant, and able authority to sit on the Reserve Board since Marriner S. Eccles presided over the New Deal.

Grampa Moe prepared for the crisis in broad strokes. But eight years into a recession which has now reached its crisis phase, it is time to make some refinements to his strategy.

The gold and silver he stockpiled has trebled in value. The pressure cookers are most likely rusted. And while the house has fallen in price, its value is unchanged. If five years from now when the crisis abates and life returns to some semblance of normality, the gold and silver will fall and the value of the home will rise again.

In this situation then it seems prudent to sell the metals now while they are extremely valuable, in the hopes that everything will eventually be okay. Under no circumstances could it possibly make sense to sell the home at its extremely distressed price, because after all this is Monterey, California.

In the Dust Bowl where did everyone go? California. California, the most fertile state in our nation, the epicenter of our innovation, is gift from God which appeared to its immigrants literally on a golden platter.

With that in mind lets turn our attention to the focus of this installment of "One way bets..." Vallejo, California.

Vallejo sits at the mouth of the Sacramento river, on the border of Napa County, in the North of San Francisco Bay. It is a 45 minute ferry ride to the Ferry Building in San Francisco, surely the most pleasant commute in the entire Bay Area. It is filled with charming Craftsman-era bungalows and is a short 10 minutes away from the new 300 million dollar cancer research facility at Turou University.

It is currently in the embroiled in the largest city bankruptcy in California history and is one of the largest casualties of the sub-prime collapse with thousands of foreclosures citywide. Houses are down in many cases 70% from their peak in early 2006. With all of the foreclosures, rental rates have gone through the roof as people struggle to find adequate housing. In this climate, it is easy to find a bungalow for a hundred thousand dollars which, at a 6% rate, require monthly payments of $600. With rents averaging $750-1000, this is a steal even if you assume the house sits vacant for a few months every now and then.

Prepare to kick yourself in 15, in 30 and again in 45 years if you miss this opportunity now.

Whip Inflation Now!

2008-09-22T19:22:00.000-07:00

Despite my feeling that the reprise of the Resolution Trust Corp. will be inflationary, the Ebay Whip Inflation Now indicator is not flashing red. The "Ebay Whip Inflation Now" Indicator you may ask? Actually, it's my own invention.
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Since January, every time inflation has surfaced as the predominant worry in the economy, the price of Ford-era Whip Inflation Now buttons has surged. Today the price action appears calm. Perhaps this bailout will actually accomplish its goal of preventing deflation while not proving too inflationary. But more likely with today's $25 surge in oil or the $180 leap in gold over this week people are more worried about the future than feeling ironically nostalgic about the past. The next button goes on sale in six days. We'll know soon enough.

When one door closes...

2008-09-21T17:22:00.000-07:00

The upcoming reprise of the Resolution Trust Corp., will weigh on the dollar in the near term and the implications of this course of action are a little hard to suss out. One one hand it will strengthen the dollar if the U.S. finance industry and by extension the economy is put on decent footing. On the other hand, it will massively increase the Federal Budget leading to a surplus of Treasury bonds. Since the government is in effect setting a floor under mortgaged backed securities, it is in effect inflating away the value of the debt in order to prevent a deflationary unwind.

While I have worried quite a bit recently about the potential for a deflationary outcome to the turmoil, it is instructive to remember that Bernanke is the country's foremost scholar on the Great Depression and determined to prevent deflation at all costs. Much of my concern was caused by the fact that I could not foresee further mechanisms for addressing the deflationary spiral. This new gambit by Paulson & C0. allays those fears.

The dollar will not collapse. Much as we have seen the correlation between the direction of the Euro and the direction of commodity prices breakdown over the past three weeks, we may be in for a period where inflation accelerates while the dollar's relative strength against its trading partners continues. If you just went, "Huh?!" I empathize. I am not sure that this is even possible according to the laws of economics, but this is one of the reasons I'm writing on this website. If you have any ideas on this unorthodox notion, please let me know.

One way bets... Charles Rangel

2008-09-20T01:01:00.000-07:00

Do you think Charles Rangel will be forced out as chairman of the Way and Means committee by Dec. 31st 2008? The odds are good and the spread is better. On the Intrade Prediction Markets, you can speculate on anything from Barack Obama becoming President, to Israel attacking Iran before the end of 2009, to the likelihood of mad cow disease emerging in the American herd. When forced to put their money on the line, the wisdom of the crowds always trumps simple opinion polls.

It works so well that the CIA briefly considered setting up a market along the lines of Intrade.com in order to ask people to speculate on where the next terrorism attack would occur. Unfortunately, the project was shelved because the administration deemed it too insensitive.

The accuracy of Intrade is well documented, accurately predicting all of the Senate election outcomes in 2006. Betting sites are great for determining how in-step your opinion is with general reckoning and the direction to which they're out of alignment. You can bet for or against yourself, depending on where you see the equilibrium. With 2:1 odds on Rangel being removed, I think the price is way out of alignment. According to the NY Post, Pelosi's spokesman denies that Pelosi will insist on Rangel stepping down. But with the current price, you'll see 100% gain if you believe Pelosi will do the right thing.

Crisis averted for now...

2008-09-18T13:23:00.000-07:00

So as I wrote last night, the relative stability in the Yen proved to be a good indicator for the fact that the markets would pull through. This does not mean that the crisis is over, but stocks should rally for the next month or so. The next shoe to drop will be defaults in the corporate bond sector, which will prove that the chaos in the markets over the last 14 months has spread to the real economy. But given the extremely weak covenants in the bond market in the second half of 2006 and the first half of 2007, these defaults will take place later in the cycle then normal. That being said, almost two years out from the period of lax underwriting the defaults can't be too long now. So don't you be to long either. Sell into the rally.

Harry Reid Says Congress Won't Act on Markets

2008-09-17T15:22:00.001-07:00

Because quote, "NO ONE KNOWS WHAT TO DO."
At least they're being honest. I was aghast during the Bernanke's testimony before congress in July 2007 when no one addressed the looming crisis in the credit default swap market and I realized that I, with no formal economic training, knew more than members of congress did. That being said, I think that these days we're getting more or less equal.

The Fear Gauge

2008-09-17T15:22:00.000-07:00

Today was the most fearful day in the markets that probably anyone living can recall. Gold surged 11%. Banks essentially stopped loaning money to each other. At one point banks were so scared that they were willing to invest in 3 month U.S. government debt (which they can use as collateral in case of disaster) for 0.03%, essentially for free. This was the lowest rate anyone has seen since the Second World War. The Vix, a measure of the amount of volatility traders expect over the next thirty days, reached its highest point since the crisis began last July. Since its inception it has only been this high twice, once during Russia's default on its debt in 1998 which caused the largest hedge fund collapse up until that time, and once during 2002. At its current level the Vix indicates that the S&P 500 will move up or down by 10.4% over the next 30 days. My personal feeling is that this is either the end of things as we know it or the worst its gonna get, staring into the precipice wise. Since I've been expecting Armageddon for since 2006 the fact that it hasn't happened yet is encouraging. Also despite the extreme stress in almost all markets, the Japanese yen which has typically surged during times of crisis has remained steady over the past 2 days. Finally, for the past 14 months it has been profitable to bet on volatility declining every time the Vix has broken 30 on an intra-day basis. I believe it is extremely unlikely that the Vix will break 40. That said, I have no idea what other policy initiatives the central banks of the world will pull out of their pockets. They can't just make bad loans good, and despite the massive injections of liquidity into the markets, there is no way that temporary liquidity can solve credit problems. Oh and by the way, the Federal Reserve has run out of money and has asked the Treasury to begin borrowing money on its behalf so that it can continue to function

Europe's Enthusiasm May Accidentally Defeat Obama

2008-09-17T02:55:00.001-07:00

Since 1976, in every presidential election year when gasoline prices were lower than they were in the previous presidential election year, the party in the White House remained in the White House. While the prospect of prices declining to their 2004 level is extremely unlikely in the next 8 weeks, their recent pullback will have a large psychological impact on the public. Therefore it is ironic to note the supporting role Obama played in their rapid decline.

The Euro/US Dollar exchange rate is primarily driven by economic factors, but sentiment also plays an enormous role. The recent astounding crash in the Russian Rouble immediately upon their engagement with Georgian forces comes to mind. Therefore I find it extremely interesting that while the economic news about Europe deteriorated precipitously in the months leading up to July, the actual breakdown in the Euro began within days of Obama's speech to ecstatic crowds in Berlin. This rise in the dollar in turn reduced inflationary pressures making oil and other commodities less attractive investments. While Europe remains enthusiastic about an Obama presidency, their trader's vote of confidence may have unintended consequences.

The Architecture of Washington Mutual

2008-09-17T00:24:00.000-07:00

The saddest thing about the demise of Washington Mutual is the loss of the one true champion of architecture in corporate America. Never has a financial firm embraced architecture as an expression of their role in the genesis of personal wealth with such a radical and catholic program.

The Palm Springs Branch:

Sunset and Vine, allegedly (I thought this was on Wilshire:)

Sunset and Vine, Mosaic Detail:

Oakland (I think:)

Early 20th Century Sketch of a Branch:

Somewhere in the San Fernando Valley:

This Spanish Colonial Ranch empathizes with the aspirations of elderly tract home mortgage applicants in the greater Orlando area.

The Carpets are Falling

2008-09-16T21:42:00.000-07:00

Back in January I thought I had a foolproof plan to survive the turmoil. I assumed the recession would be inflationary. (to comfort my fiancee I assured her it would be just like the most glamorous moments of the 70's) The only way I could imagine the debtors in this country getting out of trouble was for inflation to take off in such a way that everyone's debts would shrink as they paid them back with inflated dollars.

I had long planned for the two possible recession scenarios. If it was inflationary, I would move into hard assets like real estate and art. If it was deflationary, well I would hide under the mattress with my cash.

I thought I had a foolproof plan, I would buy vintage keyboards, oriental rugs, and some chinese vases. Keyboards to sell to aging yuppies or trust fund hipsters, rugs because they're pretty, and Chinese pottery because at some point the Chinese will want their heritage back (unless they get really good at counterfeiting that too).

I also had a tube of that poisoned Chinese toothpaste which I'd bought in a dollar store in Manhattan and held onto after it made me really sick because I figured lawsuits are good for income in any type of recession.

I was also aware that the Fed was taking an enormous gamble, hoping to create inflation so fast that commodities too became a speculative bubble primed to burst leaving the stimulative effects of easy money without the troubling result of embedded structural inflation.

But now that this gamble paid off better (it seems) than I could have possibly imagined I am faced with a troubling prospect. No one seems to have any money to purchase keyboards.

The prospect of carpet prices falling terrifies me much more than any sort of stock price declines, because if we have truly entered into a deflationary phase, nothing will be glamorous and our debts will become increasingly onerous as we pay them back with our stagnant wages.

The only bright side I can see is that this scenario will keep the bond holders happy which will continue to enable our government to do what it does best, spend its way out of trouble.

Robinson Crusoe and the Subjectivity of Desire

2008-09-16T21:03:00.000-07:00

“Price is what you pay. Value is what you get.” -Warren Buffett

What matters to us and what price? Until the 1860’s, economists such as Adam Smith and Karl Marx struggled to develop a compelling theory to explain how humans qualify value and quantify price. Smith thought that the value of a good was a gestalt of the various costs required in its manufacture. Marx sort-of believed that a good’s value was determined by the amount of the labor required put the good together. The Austrian economist, Carl Menger, was the first to articulate in a brilliant and compelling fashion, how humans value goods and derive their price at the market.

Menger uses the example of Robinson Crusoe shipwrecked on his island. Let’s assume Crusoe has 100 cups of water at his disposal each day. Crusoe determines that he requires 10 cups of water in order to feel healthy and hydrated. He also needs 50 cups of water to irrigate his crops. He uses 25 cups for washing his clothes and dishes, and he uses the remaining 25 cups to water flowers in his garden. He has no further need for any more water.

What is the value of one additional cup of water: the 101^st cup? Zero. It has no value because Crusoe has no use for it. The 101^st cup, Menger terms “non-economic.” Looking at this metaphor from the other extreme, if Crusoe’s spring dries up and he is left with only one cup of water, the value of this one cup is priceless. It means the difference between life and death.

Menger posits that all human interactions in the marketplace are composed of sliding valuations, valuations bordered at their extremes by the non-economic and the priceless goods. Menger, therefore, strikes directly at the subjectivity implicit in the vast majority of these pricing decisions: the subjectivity of desire.

Absent the terrible coercion of poverty, we predicate our decisions of whether to buy or sell purely within the framework of our own sense of justice. In the vast majority of our purchases and sales, we only ask, “What is the value of this good to me, and is the price a fair representation of its value?”

Money provides a handy calculus for this determination. By referencing all goods with respect to their price in dollars, we manage to shackle our subjective musings under a link of objectivism. Our ration of water, to extend the Crusoe metaphor, is our weekly paycheck; and after accounting for the basic needs of our survival, we can begin to attend to our wants.

It is for this reason that inflation fills us with dread. The rising cost of bread breeds anxiety because it sows doubt in our minds about our ability to pay for our needs. But more subtle, sinister, and insidious is the inchoate notion deep in the back of our minds that the markings on our yardstick are in flux; that money, the arbiter of all goods, is no longer predictable, discernible, or just.